Voyages Soleil The Hedging Decision - Answers

Edanaz Ulutaş 2293629
Q1-
The Future of Canadian Travel Industry Over the Next Six Months
Since the 9/11 terrorist attack cause Canadian travelers to question the safety of air travel
and travel to the US, Canadians are still unwilling to travel with airlines or go on a vacation in
the US. Therefore, demand for travel will be low over the next six months.
Since many tour operators went bankrupt after 9/11, the remaining companies panic about
the possibility of bankruptcy. Also, all of them projected that the demand would be low over
the next six months, so there is a tough competition in capturing customers. One way of
capturing customers is offering low prices, and since hotels only take payments in US dollars,
and tour operators receive Canadian dollars from customers, they are faced with an
exchange rate risk. Therefore, due to exchange risk, they supply less.
In conclusion, the Canadian travel industry will have a low volume over the next six months.
The Future of Canadian Travel Industry Over a Year
Since the Canadian GDP still has a positive growth rate, the travel industry will start to
recover. Customers’ opinions about the safety of air travel and travel to the US will start to
change in a positive way, and the demand for travel will increase. The panic in the travel
industry will quiet down, and the supply will increase, too.
In conclusion, the Canadian travel industry will be started to recover over a year.
Q2-
The Value of the Canadian Dollar Over the Next Six Months
As we observed in late March 2002, investments made in Canada earn a higher interest rate
than investments made in the US for a six-month horizon. Since the investors’ trust in the US
economy shrank due to the 9/11 terrorist attacks and corporate scandals, Canada’s higher
interest rate may attract foreign investors. Additionally, the Canadian stock market index
seems stabilized towards the end of 2001. These events will increase the demand for the
Canadian dollar, and the value of the Canadian dollar may appreciate against the US dollar.
However, the Canadian dollar follows a depreciating pattern against the US dollar since
1998, and the Canadian dollar hit its lowest value in February 2002. Thus, the increased
demand for the Canadian dollar will be offset by the depreciating pattern.
In conclusion, the Canadian dollar is expected to stay nearly the same in the next six months.
The Value of the Canadian Dollar Over a Year
According to the International Fisher Effect (IFE), currencies with high interest rates are
expected to depreciate in the future because the higher interest rate is only the effect of
higher inflation rates in the country. This can be true for Canada, too. When we look at the
table in Exhibit 6, we see that the consumer price index (CPI) of the US stays the same in the
last six months of 2001, even though the 9/11 terrorist attacks harmed the US economy.
However, when we look at the Canadian CPI in the last six months of 2001, there is a steeper
increase. Since CPI is an indicator of inflation, we can say that Canadian inflation is higher
than US inflation. So, as IFE says, the higher interest rate in Canada is just a factor of high
inflation, and the Canadian dollar will lose its purchasing power over time.
In conclusion, the Canadian dollar is expected to depreciate over a year.
Q3-
Like Canadian citizens do not want to go to the US for safety purposes in the next six
months, investors also do not want to invest in the US for the next six months due to
corporate scandals and the 9/11 terrorist attack. Thus, for the next six-month horizon, the
demand for the Canadian dollar will increase since domestic citizens and foreign investors
want to hold Canadian dollar, but this increase will offset by the depreciating pattern of the
Canadian dollar against the US dollar. So, the future of the Canadian travel industry and the
Canadian dollar over the next six months are related to each other.
Over a year, the Canadian citizens' demand for tours started to increase. This means that
tour operators need to sell the Canadian dollars to buy the US dollars since hotels only
accept payments in the US dollar. Hence the demand for the US dollar will increase, and this
will cause a depreciation in the value of the Canadian dollar against the US dollar.
Additionally, the higher interest rate in Canada is a product of the higher inflation, so the
value of the Canadian dollar is expected to depreciate. So, the future of the Canadian travel
industry and the Canadian dollar over a year are related to each other.
Q4-
Do Nothing and Wait Until October
If Dupuis do not want to hedge Voyages Soleil’s payables and decided to wait until October,
they will face with three possible scenarios at the time of payment:
1- The Canadian dollar stays same (Spot rate in October = US$0.6298/Cdn$)
 The value of accounts payable will equal to US$60000000 / (US$0.6298/Cdn$) =
Cdn$95268339.16
2- The Canadian dollar depreciates against the US dollar (Spot rate in October <
US$0.6298/Cdn$)
 The value of accounts payable will more than Cdn$95268339.16
3- The Canadian dollar appreciates against the US dollar (Spot rate in October >
US$0.6298/Cdn$)
 The value of accounts payable will less than Cdn$95268339.16
As it can be seen in the table, small changes in the exchange rate varies accounts payable
amount between Cdn$92307692.31 and Cdn$100000000. So, waiting six months puts
Voyages Soleil into too much exchange rate risk.
Employ a Forward Contract

Since Voyages Soleil need to sell Canadian dollar to buy US dollar, it will take a long position
in a six-month Cdn$/US$ contract. At the expiration date Voyages Soleil going to buy US
dollars and pay for them with Canadian dollars.
At the expiration date Voyages Soleil will pay US$60000000/(US$0.6271/Cdn$) =
Cdn$95678520.17 to buy US$60000000.
 With the help of the forward contract, Voyages Soleil is not going to pay more than
Cdn$95678520.17 to buy US$60000000. So, the forward contract helps Voyages Soleil to
reduce exchange rate risk.
Borrow Cdn$ Convert It into US$ and Invest In US$
In order to be able to pay its payables, Voyages Soleil needs to have US$60000000 on hand
on October 1, 2002. Thus, at the end of the six-month investment period, the amount
Voyages Soleil get from its investment should equal to US$60000000. So, the amount they
should invest today is equal to the present value (PV) of the US$60000000.
 PV of US$60000000 is:
US $ 60000000÷ [(1+ 0.0165)0.5 ]=US $ 59511042.57
So today, on April 1, 2002, Voyages Soleil need to borrow the Canadian dollar equivalent of
US$59511042.57 from the bank for six months.
 Cdn$ equivalent of US$59511042.57
US $ 59511042.57 ÷($ 0.6298/Cdn $)=Cdn $ 94491969.78
On October 1, 2002 Voyages Soleil will owe the bank
Cdn $ 94491969.78 ×¿
 In that situation the effective exchange rate is
US $ 60000000÷ Cdn $ 95759115.11=US $ 0.6266/Cdn $
Evaluation of Alternatives
Since the tourism sector expected to have a low demand in the next six months, waiting until
October has a high exchange rate risk. Additionally, the companies in the tourism sector are
in panic of the fear of bankruptcy. So, risking its profitability by waiting until October is not a
wise move for Voyages Soleil.
Buying a forward contract is the best option for Voyages Soleil. Because it locks the payables
into a known amount and reduces exchange rate risk. Additionally, the value of the Canadian
dollar expected to stay same in the next six months, so the forward rate is suitable with this
expectation.
Borrowing Canadian dollar and investing in US dollar is more costly than buying a forward
contract. Additionally, the effective exchange rate in that alternative is not in line with the
expectations on the value of the Canadian dollar in next six months.
 The best option for Voyages Soleil is buying a forward contract.

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Edanaz Ulutaş 2293629

In conclusion, the Canadian dollar is expected to depreciate over a year.

Employ a Forward Contract

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