HSBC Strategic Marketing Analysis - Research Paper Example

1153473 DUSC Executive Summary USASupercars has entered into a contract to supply luxury sports cars to s in Canada, Japan, South Africa, USAand the UK. The selling price is based on the delivery date and all payments are to be made in the customers’ currency. HSBC has made a sure sum offer of $2,150,000 based on fluctuations in the foreign exchange rates. This report provides an analysis of the offer from both perspectives and concluded as follows. Based on the average expected profit of $2,187,000 and standard deviation of $34,811 the offer should not be accepted since there is a high probability (83.4%) that USASuperCars can earn more. On that basis HSBCs offer is not a good one. The Sales Manager of USA SuperCars is more risk averse than the CEO since he does not want to take any risks at all no matter how small. In addition to exchange rate risk HSBC also faces credit, sovereign and operational risks. Payment in three months is beneficial to USASuperCars while HSBC prefers 12 months. The main reasons are opportunity cost and the time value of money. There is a 16.6% probability that the bank will incur a loss from the transaction. HSBC expects to make a profit of $37,148 from the transaction. However, the Value at Risk is -$19465.55 based on a 5% probability of loss. Hedging strategies including forward rate and futures contracts should be used to set-off losses. The bank could also borrow against future receipts. Table of Contents 1.0 Introduction 2.0 Analysis of the revenue potential of USASuperCars 2.1 Expected profits of USASuperCars 2.2 Comparison of HSBCs offer with USASuperCars earnings potential 2.3 The best payment schedule for USASuperCars 3.0 Factors of HSBC to considerations 3.1 An Analysis of HSBC’s Risks 3.1.1 Credit risk 3.1.2 Operational risk 3.1.3 Sovereign risk 3.2 The Likelihood of HSBC incurring a loss 3.3 The preferred payment schedule for HSBC 3.3.1 Time value of money 3.3.2 Opportunity cost associated with paying early 3.3.3 Risk of default 3.4 Optional strategies available to HSBC to prevent losses 3.4.1 Forward contract 3.4.2 Futures contract 3.4.3 Borrowing 4.0 Recommendations on the way forward for HSBC 5.0 Conclusion 1.0 Introduction USASuperCars is a luxury sports car dealer. The company recently signed a contract for the sale of cars to several customers around the world. The fulfilment of this contract is expected within the next 12 months. The contract which allows for a fixed exchange rate on delivery of the vehicles is expected to be fulfilled within the next 12 months. There is uncertainty due to exchange rate volatility. The Bank of America has provided information on estimates and the range within which it is likely to move. This report considers the risks including exchange rate risks as well as the benefits of the contract. It also considers an offer in the sum of $2,150,000 from HSBC in return for the revenue associated with the transaction. Additionally, it compares two payment schedules from the point of view of both parties. An assessment of the risk factors affecting HSBC and how they can be minimized without converting the currencies into dollars has also been provided. 2.0 Analysis of the revenue potential of USASuperCars In order to facilitate a reasonable assessment of USASuperCars revenue potential two things are of major importance. Firstly, a determination of the average/mean revenue of USASuperCars would be useful as a reference point for any discussion or negotiation. The mean takes into account the company’s expected high and low earnings. Secondly, the range within which the company’s revenue is likely to deviate from the average figures will help in the decision making process. The standard deviation provides information on how far below expectations earnings is likely to fall and how high it could rise. This will help to facilitate the discussion relating to HSBC’s offer of $2,150,000. 2.1 Expected profits of USASuperCars A determination of the likelihood of USASuperCars achieving various levels of revenue is critical to the decision to purchase the company’s profit. The information from the bank stated that exchange rates are independent and normally distributed. Therefore, the inclusion of a normal distribution function can be used to facilitate a better discussion on HSBC’s offer. Appendix 1 provides information to facilitate this process by calculating the mean and standard deviation. These calculations provide information relating to various probabilities that profits will be above or below certain thresholds. The mean or average profit expected from the contract is $2,187,148. However, a standard deviation of +/-$38,311.24 from the average profit is expected. Therefore, USASuperCars profit is likely to fall between $ 2,152,837 and $2,225,500 and so offers within that range will be beneficial to the company. In order to gage the likelihood of the company’s profit exceeding or falling below various thresholds several calculations have been performed. The information obtained from the results indicates that there is a 36.7% and a 16.1% probability that profit will exceed $2,200,000 and 2,225,000 respectively. This means that there is a 20.6% chance that profit will be between $2,200,000 and $2,225,000. Part 2 of the Appendix provides the details. An illustration of the information using the standardized normal distribution is provided Figure 2 below. Figure 2a- Probability of profits exceeding $2,200,000 Figure 2b – Probability of profit exceeding $2,225,000 Figure 2a and Figure 2b illustrates the probability of profits exceeding $2,200,000 and 2,225,000 respectively. The areas shaded in blue and green indicates that the respective probabilities are 36.7% and a 16.1%. The probability of profit falling below $2,160,000 and $2,130,000 is 23.9% and 6.8% respectively. That represents a 17.1% chance that profit will fall between $2,130,000 and $2,160,000. Detailed calculations are provided in Part 3 of the Appendix and illustrations are provided in Figures 3a and 3b below. Figure 3a – Probability of profits falling below $2,160,000 Figure 3a indicates that there is a 23.9% chance that profits will fall below 2,160,000. This suggests that the probability of profits falling between the mean value of $2,187,000 and 2,160,000 is 26.1%. Figure 3b – Probability of profits falling below $2,130,000 Figure 3b shows a 6.8% chance of profits falling below $2,130,000. Therefore, the probability of profits falling between $2,130,000 and $2,187,148 is 43.2%. 2.2 Comparison of HSBCs offer with USASuperCars earnings potential The offer of $2,150,000 by HSBC does not compare favourably with USASuperCars earnings potential. Based on the probability calculations shown in part 4 of the Appendix there is an 83.4% chance of USASuperCars earning profits in excess of $2,150,000. This translates to a 16.6% chance of the company earning less than $2,150,000. Figure 4 provides a pictorial representation of that information. Figure 4 The information in Figure 4 above indicates that there is a high probability that profits will be greater than $2,150,000 and so the risk of earning less is only 16.6%. This information suggests that the offer is not a good one for USASuperCars. The Sales Manager at USASuperCars is willing to accept HSBCs offer but the CEO is not. This suggests that the Sales Manager is more averse to risk. The Sales Manager is not willing to gamble for a higher payoff because that may not be realised. The CEO is willing to wait on a better deal which may not be forthcoming. However, the payment schedule could make a lot of difference to the transaction. 2.3 The best payment schedule for USASuperCars According to Homer and Leibowitz (2013) the evaluation of an investment in which money is paid now for returns at a later date is critical. The impact that time has on both present and future value is also necessary since a dollar today is worth more than a dollar in three months time and even more than a dollar in 12 months time. The future is uncertain and things are changing everyday and the value of money is impacted by inflation and interest rates. USASuperCars is certain what the value is today but is uncertain of what the value will be in the future. The best option for USASuperCars is three months time as this will allow for early investment and therefore early returns. 3.0 Factors affecting HSBC’s decision There are a number of factors that are critical in HSBCs decision to purchase the profit associated with the USASuperCars contract. In addition to looking at the risks and the associated returns HSBC also needs to determine which payment schedule is beneficial. These matters should be given due consideration before making a final decision. 3.1 An Analysis of HSBC’s Risks Business opportunities are assessed from the perspective of risks and returns (Crouhy et al 2001). In carrying out any transaction HSBC seeks to ensure that the returns are greater than the associated risks. In addition to foreign exchange risks, there are additional risks associated with HSBC’s purchase of the profit associated with the contract. The risks include credit risk, operational risk and sovereign risk and are explained in the paragraphs following. 3.1.1 Credit risk Credit risk is the main risk facing banks (Crouhy et al 2001). It is the risk that the creditworthiness of a creditor would have changed at the time of review (Eiteman et al 2007). This is a very likely event as buyers may not be sufficiently liquid to make payments when they become due. HSBC should seek to minimise this by including a related clause in the agreement. 3.1.2 Operational risk Operational risk is the risks that businesses face in carrying out their daily operations. It is a broad category that includes human factor risk, legal risk, liquidity risk, regulatory risk and others (Crouhy et al 2001). In international trade the possibility of goods being damaged cannot be ruled out and so it is likely that the vehicles may not arrive in good condition. If the vehicles are not insured against damage during shipping then this could have a negative impact on profits. Therefore, HSBC should include a provision in the contract that guarantees delivery in good condition. 3.1.3 Sovereign risk Sovereign risk is the risk that foreign firms may not be able to honour their obligations due to Government policies (Eiteman et al 2007). Sovereign risk is part of political risk. The contracts were signed with foreign companies and the possibility exists that they may be prevented from honouring them. 3.2 The Likelihood of HSBC incurring a loss The risk of HSBC incurring a loss on the transaction can be assessed on the bases of the probability of loss and the Value at Risk (VAR). The information used to analyse the deal from USASuperCars’ perspective can also be used by HSBC in their analysis. The information in Part 4 of the Appendix as well as Figure 4 suggests that there is a 16.6% chance that profits will be less than $2,150,000. However, the probability of earning a profit on the transaction is higher. In fact, the information suggests that it is highly likely that HSBC expected profit is $37,148 ($2,187,148 - $2,150,000) .See Part 9 of the Appendix for further details. This gain represents only 1.7% and would be advantageous to HSBC if the 12 month schedule is agreed. Value at Risk (VaR) is the risk that a certain value, normally 5%, of an investment will be lost (Bodie et al 2011 ). Using the NORMINV formula in Excel, the resulting standard deviation is -1.64485. This information can be used to determine VaR. The calculations in Part 9 of the Appendix indicate that VaR -$19465.55. Therefore, there is a 5% chance that the company could lose $19,465.55 3.3 The preferred payment schedule for HSBC The two payment options are three and 12 months. The preferred payment schedule for HSBC is the latest time possible which is 12 months. This can be assessed on the bases of the time value of money, the opportunity cost of paying earlier rather than later, and the risk of default. 3.3.1 Time value of money Money received today is worth more than a dollar received in the future since it can be invested to earn interest. The same applies to paying out money earlier rather than later. This is further discussed in relation to opportunity cost which is closely related to the time value of money. 3.3.2 Opportunity cost associated with paying early The funds for the purchase can be loaned to borrowers between the two time periods, (3 and 12 months) thus bringing in substantial interest income for HSBC. The opportunity cost of paying in three months is much higher due to the income that would be lost. The preferred payment period for HSBC is one that maximises its revenues and the payment in 12 months would facilitate that. 3.3.3 Risk of default The contract is for 12 months and it is possible that during that time period payment issues may arise. If the contract period coincides with the payment period then it would be beneficial to HSBC, especially if any of the customers default on their obligations. The 12 months would therefore give HSBC the opportunity to review the credit risk associated with each customer. 3.4 Optional strategies available to HSBC to prevent losses In addition to converting all currencies received into dollars, there are several hedging strategies that HSBC could use to maximise income and reduce losses. The purpose of hedging is to mitigate or offset exposure to risk associated with price changes (Titman et al 2013). There are several hedging strategies that have proven to be effective. They include forward contracts, future contracts and borrowing. 3.4.1 Forward contract In a forward contract, the price is agreed at the time of the contract for delivery at a stated future date. The price is locked in and so adverse changes in price are removed. HSBC expects to receive about five (5) different currencies, one of which is US$. The company wants to avoid foreign exchange losses and so a forward contract would allow HSBC to sell the expected foreign currency receipts at a forward rate. 3.4.2 Futures contract A futures contract allows firms to hedge against price risk in the same manner as a forward contract. HSBC will have foreign exchange to sell and so the bank can sell a futures contract. This is described as a short hedge. Doing so will minimise the loss in value resulting from currency fluctuations. 3.4.3 Borrowing Borrowing in the currency to be received can also help to reduce losses. However, there is the risk that the money may not be received on time. The charges including interest and late payment fees could make this option more costly. 4.0 Recommendations on the way forward for HSBC If the offer is accepted by USASuperCars, HSBC would face several risks including foreign exchange risk. All of these risks can be managed to the Bank’s benefit. Foreign exchange risk can be satisfactorily managed using forward and futures contracts. In terms of payment, a 12 month payment schedule would be more beneficial to HSBC. This will allow the company to assess risks and maximise earnings. 5.0 Conclusion HSBCs offer is not a good one as USASupercars is more likely to earn a higher profit than that offered. However, if the offer is accepted the three month payment schedule is better for USASuperCars while the 12 month schedule favours HSBC. HSBC will be exposed to several risks including sovereign, operational, foreign exchange and credit risk. Hedging strategies including forward and futures contracts are highly recommended. This will minimise foreign exchange risks which is one of the main risks associated with this contract. Appendix Part 1 Calculation of mean and standard deviation Worldwide Orders Exchange Rate (to $) Customer Quantity Selling Price Mean Standard Deviation Expected Revenue ($) Variance Standard Deviation UK 12 57,500 1.4 0.041 966,000 800324100   Japan 1 5 8,400,000 0.009 0.00045 378,000 357210000   Japan 2 3 9,000,000 0.009 0.00045 243,000 147622500   Canada 1 1 97,000 0.824 0.0342 79,928 11005142.76   Canada 2 3 100,000 0.824 0.0342 247,200 105267600   South Africa 2 4,100,000 0.0211 0.00083 173,020 46321636   USA 1 100,000     100,000 0   Total 27       2,187,148 1467750979 38,311 Table 1 Part 2 The normal distribution is dependent on the mean and variance. Once these two parameters are known probabilities can be calculated. A statistical table useful; however, in order to use it a normally distributed variable needs to be converted into standardised normal variable, Z(Gujarati 195). The Z score is calculated using the following formula. Z= Where, μ is the population mean and δ the standard deviation of the population. 2 a The probability that revenue will exceed $2,200,000 is calculated in the table below Part x μ δ Z 2a 2,200,000 2,187,148 38,311.24 0.335463           Z = 0.1331 Using the standard normal distribution table for Z values P(X> $2,200,000) = P(Z > 0.1331) = 0.5 – 0.1331 = 0.3669 or 36.7% Part 2 b Probability that revenue will exceed $2,225,000 is calculated in the table as follows: Part x μ δ Z 2b 2,225,000 2,187,148 38,311.24 0.988013 Using the standard normal distribution table for Z P(X> $2,225,000) = P(Z > 0.3389) = 0.5 – 0.3389 = 0.1611 or 16.1% Part 3 a Probability that the revenue will be less than $2,160,000 is calculated in the following table Part x μ δ Z 3a 2,160,000 2,187,148 38,311.24 -0.70862           Using the standard normal distribution table for Z P(X < $2,160,000) = P(Z < 0.2611) = 0.5 – 0.2611 = 0.2389 or 23.9% Part 3b Probability that the revenue will be less than $2,130,000 is calculated n the following table Part x μ δ Z 3b 2,130,000 2,187,148 38,311.24 -1.49168           Using the standard normal distribution table for Z P(X < $2,130,000) = P(Z < 0.4319) = 0.5 – 0.4319 = 0.0681 or 6.8% Part 4 The probability of X > 2,150,000 is calculated as follows: Part x μ δ Z 4 2,150,000 2,187,148 38,311.24 -0.96964 P(X > $2,150,000) = P(Z > 0.3340) = 0.5 + 0.3340 = 0.8340 = 83.4% Therefore an offer of $2,150,000 would not be a good offer. Part 5 The Sales is more risk averse so he is willing to take what he can get now due to the volatility of the exchange rate as he is willing to hold the company until he can sell it at a higher expected value. Part 6 Other risks the bank is taking apart from the exchange rate risk include credit risk, operational risk and sovereign risk. Part 7 Payment in three months would be worth more than payment in 12 months. The difference is the time value of money. HSBC would refer 12 months and USASuperCars 3 months. Part 8 The probability that the bank will incur a loss is calculated as follows: P(X < 2,150,000) = P(Z < 0.3340) = 0.5 – 0.3340 = 0.1660 = 16.6% Part 9 Expected profit/loss and VaR are calculated as: Expected revenue – cost = $2,187, 148 - $2,150,000 = $37,148 VaR = (Expected revenue – 1.65 * δ) - $2,150,000 VaR = ($2,187,148 – 1.65 * 34,311.24) - $2,150,000) VaR = (2,187,148 – 56,613.55) - $2,150,000 = ($19465.55) Part 10 If the bank decides not to convert all/some of the currencies into dollars twelve month’s time then other options are available. They include borrowing, currency forward and currency option. References Bodie, Z, , Kane, A and Marcus, A.J. (2011). Principles of Investments. 9th ed. New York, NY: McGraw-Hill/Irwin Crouhy, M., Galai, D and Mark, R. (2001). Risk Management. USA: McGraw-Hill Education (Australia) Pty Ltd Eiteman, D.K., Stonehill, A.I and Moffett, M.H. (2007). Multinational Business Finance. 11th ed. USA: Pearson Education, Inc Homer, S and Leibowitz, M..L. (2013). Inside the Yield Book: The Classic That Created the Science of Bond Analysis. 3rd ed. New York, NY: John Wiley & Sons, Inc Titman, S., Keown, A.J and Martin, J.D. (2013). Financial Management: Principles and Applications. 12th ed. USA: Pearson Prentice Hall Read More