Statistics of USASuperCars - Essay Example

Contents Summary 4 Introduction 4 Body of the report 5 Table Details of car sales DD/MM/YY 11/10/1989 5 Table 2: Expected revenue and Standard deviation 6 Conclusion 9 Appendix 11 Question 1 11 Find the distribution and report the mean and the standard deviation of the uncertain revenue in $. 11 Chart 1: Mean returns for each country 12 Chart 2: Variance distribution 12 Question 2 12 a.What is the probability that this revenue will exceed $ 2,200,000? 12 b.What is the probability that this revenue will exceed $ 2,225,000? 13 Question 3 13 a.What is the probability that this revenue will be less than $ 2,160,000? 13 b.What is the probability that this revenue will be less than $ 2,130,000? 13 Question 4 14 HSBC offers to pay a sure sum of $2,150,000 in return for the revenue in local currencies. What do you think, is this a good offer for USA Supercars or not? 14 Question 5 15 In USA Supercars, the Sales manager is willing to accept HSBC’s offer, but the CEO is not. Who is more risk-averse? 15 Question 6 15 What other risks the bank is taking apart from the uncertainty in the exchange rates? 15 Question 7 15 If the offer is to pay the sure sum in three months’ time rather than in twelve months’ time, would that make any difference? When would the bank and when the company would prefer the payment to be made, and why? 15 Question 8 16 USAS uperCars has accepted HSBC’s offer. Now consider the bank’s risk, assuming the bank will convert all currencies into US dollars at the prevailing exchange rates. What is the probability that the bank will incur a loss? 16 Question 9 16 The bank defines its Value-at-Risk as the loss that occurs at the 5thpercentile of the uncertain revenue (5% left tail of the distribution). What is the bank’s Value-at-Risk and what is the bank’s expected profit? 16 Question 10 17 What other options does the bank has if they decide not to convert all/some of the currencies in twelve months’ time? 17 Summary USASuperCars signed a contract to sell 27 cars to five different countries including the USA. It was agreed that the other four countries would pay the revenue in their local currencies at the prevailing exchange rate after the delivery. HSBC however offered an offer of $2,150,00 for the purchase of the contract. The objective of the report was to conduct an analysis of risks to the company and the bank and profitability. Exchange rate data from the Bank of America was used for all the analysis. A recommendation would thus be made on whether USASuoerCars should accept the offer from HSBC. Various statistics were used in achieving this objective. The expected revenue was obtained as $ 44,218,388 and the standard deviation as $ 33,022.14. The probabilities of the mean exceeding $2,200,000 and 2,225,000 are 100% and 100% respectively. This shows that there are high chances of exceeding the mean revenue. The banks value at risk at the 5th percentile was $ and the profit was $ . A recommendation was made for the company to reject the banks offer due to the probability of higher revenue that the offer by HSBC. Introduction USASuperCars, which is based in US, markets custom built and high-end expensive cars. These sports cars are meant for the rich in the society. The company signed an agreement to sell 27 cars to five countries across four continents; the payment was to be paid after delivery in the local currency. Since the payments were to be made at a leter date and in local buyers local currency, it meant that there would be uncertainties in the final revenue that is expected at the contract. The exchange rates were provided by the Bank of America for the twelve months that followed so as to ensure a proper analysis. HSBC offered $ 2,150,000 to USASuperCars in exchange for the all the revenue in the local currencies. The purpose of the report was to find the probabilities of getting revenue in excess or under the expected value; evaluate the offer by HSBS and determine other risks that faced the bank and the company. Based on the obtained data, a recommendation was made to reject the offer by HSBS and wait for the sure sum in twelve months period. Body of the report USASuperCars signed an agreement to sell 27 cars in five countries. They included 12 cars for United Kingdom, 8 for Japan, 4 for Canada, 2 for South Africa, and 1 for USA. There are two agents in both Canada and Japan. The selling prices at each country are different, which presents different levels of risks. The exchange rates, standard deviations and mean are the same. Only one car will be for paid in USD; the others will be for in the respective local currencies on delivery at the prevailing exchange rates. These rates are not stable, which adds uncertainties about the expected returns. To help reduce this risk, the Bank of America provided an estimation of the exchange rates with their means and standard deviations. Table 1 shows the estimates by the Bank of America to eliminate the risk of uncertainty. Worldwide orders Exchange Rate (to $) Customer Quantity Selling price Mean $ Standard deviation UK 12 57,500 1.4MM/£ 0.041/£ Japan 1 5 Y 8,400,000 $ 0.009DD/Y 0.00045/Y Japan 2 3 Y 9,000,000 $ 0.009DD/Y 0.00045/Y Canada 1 1 CAD 97,000 $ 0.824YY/CAD 0.0342/CAD Canada 2 3 CAD 97,000 $ 0.824YY/CAD 0.0342/CAD South Africa 2 R 4,1000,000 $ 0.0211/R 0.00083/R USA 1 1 $ 100,000 Table 1: Details of car sales DD/MM/YY 11/10/1989 The mean was calculated by multiplying the quantity of the cars, the selling price and the exchange rate mean. The standard deviation of the expected revenue was obtained by calculating the variances between the mean of the expected revenue, then squaring them to get the variance before taking the square root of their summation to give the standard deviation. The results are as shown in table 2, which shows the expected revenue and standard deviation. Worldwide orders Exchange Rate (to $) Expected Revenue Customer Qty Selling price Mean $ S.D Mean (Q,S,M) Variance (Q,S,Sd)2 UK 12 57,500 14/£ 0.041/£ 9,660,000 786,465,936 Japan 1 5 Y 8,400,000 $ 0.099/Y 0.00045/Y 4,158,000 365,765,625 Japan 2 3 Y 9,000,000 $ 0.099/Y 0.00045/Y 2,673,000 147,622,500 Canada 1 1 CAD 97,000 $ 73.336/CAD 0.0342/CAD 7,113,592 11,005,142.8 Canada 2 3 CAD 97,000 $ 73.336./CAD 0.0342/CAD 21,340,776 99,046,284.84 South Africa 2 R 4,100,000 $ 0.0211/R 0.00083/R 173,020 46,321,636 USA 1 1 $ 100,000 100,000 =45,218,388 =1,090,461,500 Table 2: Expected revenue and Standard deviation Mean = $ 45,218,388 Standard deviation= $ 33,022.14 The expected revenue at the end of the year is $ 45,218,388. These values were obtained on the basis that all the revenue has some uncertainty or risk. This is the probability of loss present in financial methods which may hinder the achievement of adequate returns. There are also other risks including physical and credit risks that the Company has to be if it is to wait for one year for the payments to be done. Japan and Canada duo sales were treated differently so as achieve the benefit of diversification. Since, it is impractical to quantify risks in finance, the standard deviation of results from the mean represent the uncertainty of investing in any asset or portfolio. According to table 2, the deviation from the expected return is $33,022.24, which indicates the risk USASuperCars faces as a result of fluctuating exchange rates. Further calculations to identify the probability of obtaining lower or higher revenues than the mean were made so as to help the Managers make informed decisions. The probabilities of exceeding the average by $ 43,018,388 and $ 42,993,388 were found to be 100% and 100% respectively. Also, the possibilities that the averages would be less than $2,160,000 and $2,130,000 were also calculated. There are thus, higher chances of earnings exceeding the expected value than being less. This is possible on the basis of the world economic outlook that as economies try to recover from the financial crisis, the developed ones have already stabilized. The recession period is over and thus, the demand for Supercars will increase and also the exchange rates will stabilize to eliminate the competitive devaluation by nations. HSBC offered the Company $ 2,150,000 for managing its risk but this was below the revenue by $ $ 43,018,388 which is reasonable since there is less or no risk. The offer is not good since it has a probability of 0% compared to the remaining 100%. The CEO of USASuperCars would accept if it was higher than the expected return. After evaluating the offer from HSBC, the Sales Manager is willing to accept the offer from HSBC but the CEO is not, which shows that the Sales Manager is more risk-averse. Apart from risks in foreign financial transaction, the bank also faces other risks which include country, credit, physical risks, and market stagnation risks. Country risks include the changes in regulations, legislations and also the politics in those nations. Credit risk is the failure of the final buyer or car dealer to pay the expected amount in time. Physical risk is the probability of cars being damaged due to natural factors after they are delivered but before they are sold to the final consumer. Insurance cover can help manage physical risks but it results into additional costs. Market stagnation may result from economic crisis. Supposing the Company accepts HSBCs offer, it would make a difference to receive the sure sum in three months and not in a years time. Since the bank prepares to make the payment in twelve months time, the company will now prepare to receive the money in three months time. This is because on the basis of time, money is worth more now than in the future due to its potential earning capacity (Investopedia, 2014). $ 50 is worth more now than $ 50 in six months since if it is invested now; it will be more in 6 times. Also, due to inflation $50 has more value than $50 in the future. Therefore, the USA Supercars would prefer the offer is to pay the sure sum in short-term (three month) since it would get more net present value while the bank prefer the offer is to pay the sure sum in long term (twelve month) since it would benefit by earning interest from lending it. If USASuperCars accepts the offer, the probability of making a loss is 0%, which could be as a result of the earnings falling below the offer of $2,150,000. The bank chooses to define its level of risk considering some of the information at its disposal. This implies that the expected loss should be computed differently. Thus if it defines the value at risk at the 5th percentile of the revenue, then its value at risk equals and the profit amounts to If the company accepts HSBCs offer, at the end of the year, bank can convert its revenue into US dollar. There are, however, other options available at its disposal to manage the revenue. The bank can invest this money using various ways such as making bank deposits and other liquid assets. Investment can also be in capital market instruments. The bank can also swap foreign currency with other financial institutions. The swapping partners agree such that risk of exchange rate does not move more to one party than the other (Bank For International Settlements 2014). They exchange the currencies at a particular exchange rate at a specified time in the future such that the risk of exchange is not disadvantageous to either party. The currencies can also be used for other miscellaneous expenditures in the running of the Company. Conclusion The expected revenue and risks were obtained for the contract that was recently signed by USASuperCars to sell 27 cars to seven different customers. The revenue was $ 45,218,388 and the standard deviation at 33,022.14. Probabilities were calculated to help the Company decide on the offer by HSBC, which was a sure sum of $ 2,150,000. It was also found that USASuperCars would get higher returns if it waits for a year to convert the sales into dollars, however, there were risks associated with this. They included political and credit risks that the bank would face. Based on the results obtained, this report recommends that the Company rejects HSBCs offer since there is a higher possibility of achieving higher revenue than lower return. Also the exchange rates against the dollar are expected to remain stable, which lowers the risk. The worldwide interest rates are also low and are not expected to rise for the rest of the year thus there is little threat of inflation. UK, Canada and Japan are developed economies; therefore, this lowers the effect of political risks. References Bank For International Settlements 2014, The basic mechanics of FX swaps and cross-currency basis swaps.Available from[23 Nov.2014] BusinessDictionary 2014, Financial Risk. Available from: [23 Nov. 2014] Investopedia 2014, Time Value of Money. Available from: [23 Nov. 2014] Appendix Question 1 Find the distribution and report the mean and the standard deviation of the uncertain revenue in $. Standard deviation= Chart 1: Mean returns for each country Chart 2: Variance distribution Question 2 a. What is the probability that this revenue will exceed $ 2,200,000? b. What is the probability that this revenue will exceed $ 2,225,000? Question 3 a. What is the probability that this revenue will be less than $ 2,160,000? b. What is the probability that this revenue will be less than $ 2,130,000? Question 4 HSBC offers to pay a sure sum of $2,150,000 in return for the revenue in local currencies. What do you think, is this a good offer for USA Supercars or not? HSBC offers $2,150,000, which is below the expected revenue. This is logical since it reduces the risks for the Company. The probability of getting revenue below $2,150,000 is 0%, thus the offer is not good since there is a higher probability (100%) of obtaining earnings above this value. It can be easily inferred that if USA Supercars accepts HSBCs offer, the USA Supercars revenue will be less than the expected revenue of USD 45,218,388 which is USD 43,068,388 higher than the HSBCs USD 2,150,000 payments for the revenue. However, the advantage of this offer is that the USA Supercars can transfer all the uncertainty of the revenue to the HSBC. From this point of view, the excessive USD 43,068,388 can be considered as the pay fee of the transfer risk. Whether it accepts HSBCs offer or not, this depends on the Supercars profit range under this contract. Question 5 In USA Supercars, the Sales manager is willing to accept HSBC’s offer, but the CEO is not. Who is more risk-averse? The Sales manager is more risk-averse. Question 6 What other risks the bank is taking apart from the uncertainty in the exchange rates? The bank is obviously taking other risks apart from the uncertainty in the exchange rates, which include default risk (for example, customer defaults to pay the receivable to USA Supercars; USA Supercars may fail to deliver cars to the customer), liquidity risk (bank less liquidity to pay the sure sum of USD 2,150,000 to USA Supercars). Question 7 If the offer is to pay the sure sum in three months’ time rather than in twelve months’ time, would that make any difference? When would the bank and when the company would prefer the payment to be made, and why? Yes, it makes a difference. Since the bank prepares to make the payment in twelve months time, the company will now prepare to receive the money in three months time. This is because on the basis of time, money is worth more now than in the future due to its potential earning capacity (Investopedia, 2014). $ 50 is worth more now than $ 50 in six months since if it is invested now, it will be more in 6 times. Also, due to inflation $50 has more value than $50 in the future. Therefore, the USA Supercars would prefer the offer is to pay the sure sum in short-term (three month) since it would get more net present value while the bank prefer the offer is to pay the sure sum in long term (twelve month) since it would benefit by earning interest from lending it. If the Company collects this money earlier, it can invest with it and earn revenue while still delaying the payment date. Question 8 USAS uperCars has accepted HSBC’s offer. Now consider the bank’s risk, assuming the bank will convert all currencies into US dollars at the prevailing exchange rates. What is the probability that the bank will incur a loss? The probability of making loss is 0%. It indicates that the revenue will be above the offer of $ 2,150,000 Question 9 The bank defines its Value-at-Risk as the loss that occurs at the 5thpercentile of the uncertain revenue (5% left tail of the distribution). What is the bank’s Value-at-Risk and what is the bank’s expected profit? The HSBCs value-at-risk is and its expected profit is at Question 10 What other options does the bank has if they decide not to convert all/some of the currencies in twelve months’ time? The bank can invest this money using various ways such as making bank deposits and other liquid assets in the money economies. Investment can also be in capital market instruments in the safe emerging markets. The bank can also swap foreign currency with other banks or financial institutions. The swapping partners agree such that risk of exchange rate does not move more to one party than the other (Bank For International Settlements 2014). They exchange the currencies at a particular exchange rate at a specified time in the future such that the risk of exchange is not disadvantageous to either party. The currencies can also be used for other miscellaneous expenditures. Read More