Kenneth R. Szulczyk
won appreciates, subsequently, Caterpillar would pay more U.S. dollars to satisfy this
obligation. If the spot exchange rate remains the same, then Caterpillar would pay $5.025
million for the company, calculated in Equation 8.
ݐ݊ݑ݉ܽ($)= 6 , 030 ݈݈݅݉݊݅ ݏ݊ݓ൭$1ൗ 1 , 200 ݏ݊ݓ൱=$5. 025 ݈݈݊݅݅݉ (8)
Strategy 2: Caterpillar could use a forward contract to lock in a future exchange rate.
Consequently, this strategy has no exchange rate risk, and Caterpillar would pay $4.785 million,
computed in Equation 9. Clearly, Strategy 2 is better than Strategy 1 because Caterpillar knows
the exact future value of its legal obligation.
ݐ݊ݑ݉ܽ($)= 6 , 030 ݈݈݊݅݅݉ ݏ݊ݓ൭$1ൗ 1 , 260 ݏ݊ݓ൱=$4. 786 ݈݈݊݅݅݉ (9)
Strategy 3: Caterpillar could buy a call option to buy wons at a fixed price, and this
strategy has no exchange rate risk. Thus, Caterpillar would pay the premium of $150,750,
calculated in Equation 10. Then Caterpillar will exercise this call option if the won appreciates
relative to the U.S. dollar. Caterpillar would pay $5.025 million at most, computed in Equation
- Although this Strategy is worse than Strategy 2, Caterpillar would use this strategy if it
believed the Korean won would depreciate, which reduces Caterpillar's obligation. Then, if the
Korean won appreciates, Caterpillar will exercise the call option.
݉ݑ݅݉݁ݎ($)= 6 , 030 ݈݈݊݅݅݉ ݏ݊ݓ( 0. 03 )൭$1ൗ 1 , 200 ݏ݊ݓ൱=$150, 750 (10)
ݐ݊ݑ݉ܽ($)= 6 , 030 ݈݈݊݅݅݉ ݏ݊ݓ൭$1ൗ 1 , 200 ݏ݊ݓ൱=$5. 025 ݈݈݊݅݅݉ (11)
Strategy 4: Caterpillar could transfer funds today into South Korea using the spot exchange
rate. Then it deposits funds into a Korean bank and earns interest for six months. Although this
strategy has no exchange rate risk, it does have a country risk. Company deposits funds in a
foreign country for six months, and in some countries, this would not be wise. We discuss a
country's risk in Chapter 20.
Caterpillar needs 6,030 million wons in six months. We work backwards to determine the
amount Caterpillar needs to deposit today, so the interest allows the balance to grow into 6,030
million wons. We calculated the present value of 5,853.3 million wons in Equation 12.
Consequently, Caterpillar uses today's currency exchange rate to transfer $4.65 million to Korea,
calculated in Equation 13. This strategy yields the lowest costs to pay that accounts payable