Problem 10.

10 Pupule Travel
Pupule Travel, a Honolulu, Hawaii based 100% privately owned travel company has signed an agreement to acquire a
50% ownership share of Taichung Travel, a Taiwan based privately owned travel agency specializing in servicing
inbound customers from the United States and Canada. The acquisition price is 7 million Taiwan dollars (T$ 7,000,000)
payable in cash in 3 months.
Thomas Carson, Pupule Travels owner, believes the Taiwan dollar will either remain stable or decline a little over the
next 3 months. At the present spot rate of T$35/$, the amount of cash required is only $200,000 but even this relatively
modest amount will need to be borrowed personally by Thomas Carson. Taiwanese interest-bearing deposits by nonresidents are regulated by the government, and are currently set at 1.5% per year. He has a credit line with Bank of
Hawaii for $200,000 with a current borrowing interest rate of 8% per year. He does not believe that he can calculate a
credible weighted average cost of capital since he has no stock outstanding and his competitors are all also privatelyowned without disclosure of their financial results. Since the acquisition would use up all his available credit, he
wonders if he should hedge this transaction exposure. He has quotes from Bank of Hawaii shown in the table below.

Spot rate (T$/$)

3-month forward rate (T$/$)
3-month Taiwan dollar deposit rate
3-month dollar borrowing rate
3-month call option on T$

33.40
32.40
1.500%
6.500%
not available

Analyze the costs and risks of each alternative, and then make a recommendation as to which alternative Thomas
Carson should choose.
Assumptions
Acquisition price & 3-month A/P, NewTaiwan dollars (T$)
Spot rate (T$/$)
3-month forward rate (T$/$)
3-month Taiwan dollar deposit rate
3-month dollar borrowing rate
3-month call option on T$
Thomas Carson's credit line with Bank of Hawaii

Evaluation of Alternatives

Values
7,000,000
33.40
32.40
1.500%
6.500%
not available
200,000
Cost

Certainty

1. Do Nothing -- Wait 3 months and buy T$ spot

If spot rate is the same as current spot rate

209,580.84

Risky

If spot rate is the same as 3-month forward rate

216,049.38

Risky

216,049.38

Certain

Although this would do nothing to cover the currency risk,

there would be no required payment or borrowing for 3 -months.
2. Buy T$ forward 3-months
Assured cost of T$ at 3-month forward rate

The purchase of a forward contract would not require any cash

up-front, but the Bank of Hawaii would reduce his available credit
line by the amount of the forward. This is a non-cash expense.
3. Money Market Hedge: Exchanging US$ for T$ now, depositing for 3-months until payment
Acquisition price in T$ needed in 3-months
Discounted back 3-months at T$ deposit rate
Amount of NT$ needed now for deposit
Spot rate, T$/$
US$ needed now for exchange
US$ carry-forward rate (3-month dollar borrowing rate)
Carry-forward factor of US$ for 3-month period
Total cost in US$ of settling A/P in 3-months with
Money Market Hedge

7,000,000
0.9963
6,973,848
33.40
208,797.85

6.500%
1.0163
212,190.81

Certain

The currency risk is eliminated, but since Thomas Carson would have to exchange the money up-front, it would require
him to borrow the money, increasing his debt outstanding for the entire 3 months.
Discussion.
This is a difficult decision. The forward contract appears to be the preferable choice, protecting him against an
appreciating T$, and creating a certain cash purchase payment. The problem, however, will be whether the Bank of
Hawaii will allow him to purchase a forward for the full $216,049.38, which is slightly above his credit line currently
in-place. If his relatonship is good with the bank, they most likely would increase his line sufficiently to allow the
forward contract.