US$ tanking vs. Euro - Effect on M3 cost?

[Los Angeles]

Based on the M3's performance compared to the RS4, I don't see why the cars would be less than $60k after options + taxes.

Since the base prices will roughly be a mid-to-high $50k, the options and tax should put the cars in the $61-63k range.


I would bet on it.

[paulyd]

Originally Posted by Seth_Horwitz

Any respectable international manufacturer will take steps to hedge against exchange risk by transacting in futures contracts, or entering into currency swaps. As the U.S. is a major market for BMW (I don't want to make up numbers, but I think it's around 50%), they undoubtedly have hedged against a weakening dollar. It would be irresponsible not to.

Whereas the above calculations are valid (I assume, I haven't verified) they don't have the exact impact on BMW's bottom line that it would seem. While the profit of each car goes down as the dollar weakens, the fact that BMW is certainly short the dollar in a hedge means that a financial institution will owe BMW a cash payment that only increases with such moves. Ideally, the hedge will exactly offset any direct losses from dollar movements. (This isn't the case, but I'm sure BMW has got it pretty close after all of these years.)

To sum things up, if the dollar weakens, BMW is making less off of "you" but by an amount that should be closely offset by an inflow of cash from their hedge's counterparty. (Net gain/loss to BMW = $0) Conversely, if the dollar strengthens, they will make more money off of "you", but have to pay out a similar amount to the counterparty.

It's late, so that may not read very clearly, but, to sum things up, BMW has "locked in" their profit margins based on projected sales, by making a currency hedge, and actively adjusting it. This enables them to have a steady income stream over time, and not have their cars get wildly cheaper or more expensive over time.

I agree with everything you have said. You very clearly explained how hedging works. But that does not solve the problem in the LONG RUN.
I will assume that BMW has properly hedged. (Which is NOT guaranteed btw http://www.time.com/time/magazine/ar...450948,00.html)

In THE LONG RUN, however, hedging does not work miracles. Once the hedges expire, BMW must purchase new ones. They all do not expire on one day, but as old ones expire, they purchase new ones. Everytime they must purchase new ones, they are hedging against the rate THAT DAY(say last yr, for example). Now, when those contracts expire TODAY, they enter NEW hedges TODAY. The hedges they enter into TODAY hedge against the rate TODAY. When the hedging they entered into TODAY expires NEXT YR, they will enter into new contracts at NEXT YR'S rate, protecting FUTURE drops.
Everytime hedge instruments expire and new ones are entered into, the rate on the day of creation takes hold. The currency has dropped from 0.83 to 0.69!
The hedge instruments created 2 yrs ago when the rate was 0.83 have expired, say last yr at 0.79. BMW protected itself for that year for that amount of decrease. From then on, however, they must accept no more than 0.79.
Then last year, BMW would hedge against a drop to anything below 0.79.(Stated rate of contract is 0.79 now NOT 0.83)
Today, it is 0.69, and so lets say BMW successfully hedged against the drop from 0.79 to 0.69. BUT NOT FROM 0.83 TO 0.79 - because it already occurred before they entered new hedge transactions at a rate of 0.79. (effectively losing 0.04 euros/$, this year and for eternity)

Now they are hedging from a rate of 0.69 to anything below thaaat. Say US$ continues to drop to 0.59 next yr. Again, BMW will have protected itself from the drop between 0.69 and 0.59, but the difference between 0.83 and 0.79 hit them. And the difference between 0.79 and 0.69 now hits them as well. All they did is protect themselves from the current yr drop from 0.69 to 0.59. Despite this intelligent move, they still are getting 0.14 less euros/$ than they were 2 yrs ago!!(0.83 - 0.69 = 0.14) The hedge simply prevented them from losing 0.24! euros/$ (0.83-0.59).

Basically, they will collect 0.59 euros for every dollar.(that we give them)
The financial institution will pay them 0.10 euros per dollar.(hedge)
Therefore, they receive 0.69 in total. (Not 0.83!)
They are still screwed compared to the 0.83 they were getting 2 yrs ago!

I quantified this difference in the OP. It does not translate into a dollar for dollar increase in price to us. I stated that. But IN THE LONG RUN, THE PRICE OF US IMPORTS WILL INCREASE. This is an economic fact. It WILL hit the M3. If not for 08, then for 09. If not for 09, then for 2010. Eventually we WILL pay the price. As soon as the hedge instruments expire, the price will increase.(again, unless BMW takes a margin hit, cuts costs, etc)

All hedging does is delay the inevitable by however long the contract lasts.
You hedge for one year, you don't have to face reality for one year. From that point forward, however, you must face reality. Additional hedge transactions will only protect you from FUTURE losses. What has already happened is now the going rate.

The only way a weakening US$ would not affect us is if BMW hedged ten zillion euros for a period of infinity. BTW, it costs money to obtain these instruments, so just the fact that BMW has to do it for the US$ is costing them extra.

If you meant that BMW hedged the entire production of the E92 M3, then yes, they don't have to raise the price of the E92. They will raise it next model. However, I highly doubt BMW contracted with BMW dealers and distributors in the USA at prior rates. The result of this would be screwing over the dealerships. They would have to pay BMW AG a stated amount of Euros which cost more dollars than they used to. This would erode dealership profits and shoot yourself in the foot. No way they hedge in such a way that the dealerships are stuck with all of the risk. Who would be a BMW dealership?

You cannot escape the inevitable.

That is a long a$$ post. I should work on my brevity. Hopefully I explained the core concept clearly and accurately enough for those who know more than me.

[lucid]

Originally Posted by chitown08

Once the M3 price is released neither one of us will be proven correct. All I am saying is this is going on in the background and companies do not hedge to infinity. They hedge for a year or two. Once those hedges expire, they must buy new hedges at the new price. And wahla, the change hits. You CANNOT escape this fact.

+1

[Seth_Horwitz]

Originally Posted by chitown08

Once the hedges expire, BMW must purchase new ones.

This would be true for a futures contract, but a currency swap can be set up with any termination date that you like. Regardless, with either instrument, the gain from the previous hedge would offset the new levels that you must pay. (Good or bad)

For example, at T0, BMW enters into a swap at the current market rate with a notional amount equal to their expected sales over the period, because they feel the exchange rate is good for the bottom line. This swap costs nothing up front, at T0, and has no value either. (You have agreed to pay the current rate, and the rate hasn't changed, so it's not worth anything.)

After the swap has ended, at T1, let's say that the dollar has weakened, and the swap has moved in BMW's favor. This swap is now worth $1B, or whatever number you make up, and BMW is paid in cash. You are correct in that BMW must now enter into a new swap, at the less favorable exchange rate that now exists at T1, BUT, BMW has just been paid in cash the exact dollar amount that offsets their new "loss" by the exchange movement.

For all intents and purposes, BMW is still in a swap with the rate provided at T0, because they have the cash payment from the termination of the first swap. This process can continue forever, with one caveat. This analysis assumes that the swap notional (or amount hedged) is constant over time. This won't be the case, so you are right to assume that their locked in exchange rate will change, but extremely slowly. Basically, the unexpected increase in BMW sales in 5, 10, or 20 years, will have exposure to exchange risk, but the beginning notional amount can carry on forever at the first rate.

The only exchange risk, is for the amount that is not hedged. The hedged amount is locked in due to a series of termination payments that are made at the end of each swap, just before rolling into a new one. When you factor in these payments with the new more or less desirable exchange rates, the net result is the original swap rate.

[SD330i]

I said there were many factors like hedging, which has now has been explained in detail. I also said that BMW is a global company. Are we forgetting that BMW makes cars in the US? Like the other gentlemen said from Australia about the cost of the M3 there, which is insane, poor chap. US is a very important market and BMW is all over the place here and abroad, they will get their profits in one way or another.

Lets keep in mind that at least 75% of all BMW are leased and the other is split by people who pay for them in cash (which one are you?). Additionally BMW has increased their product line creating more new and in effect used cars on their lot. Each car needs to be priced respectfully to create the "step up" effect. Enticing the ever aging and salary increasing public to move up and through their product line.

[lucid]

This is an interesting discussion, and I am learning from it. However, some of what's been expressed is modeling BMW as an ideal company, which takes all the necessary rational steps at the right time to achieve profits. This reminds of how some economist friends of mine think/argue in debates...Anyway, I'm interested in seeing where this thread goes. Thanks for the contributions.

[paulyd]

Originally Posted by SD330i

I said there were many factors like hedging, which has now has been explained in detail. I also said that BMW is a global company. Are we forgetting that BMW makes cars in the US? Like the other gentlemen said from Australia about the cost of the M3 there, which is insane, poor chap. US is a very important market and BMW is all over the place here and abroad, they will get their profits in one way or another.

Lets keep in mind that at least 75% of all BMW are leased and the other is split by people who pay for them in cash (which one are you?). Additionally BMW has increased their product line creating more new and in effect used cars on their lot. Each car needs to be priced respectfully to create the "step up" effect. Enticing the ever aging and salary increasing public to move up and through their product line.

@SD300i - Again, I agree with what you have to say.
I think you are just saying that the price of bimmers in the US is not going to skyrocket. I agree. BMW will find ways to combat the currency risk. I just don't know why you want to deny a basic economic principle, which is that a weakening dollar causes US imports to become more expensive, and exports to become cheaper overseas.

Therefore, my only points are that:
1)exchange rate devaluation will erode BMW profits, or increase the cost of BMW's in the US (by $5 or $2000, I do not know - too many other variables)
2)Hedging is not a miracle worker. It prevents marginal losses in the short term. You cannot hedge every euro into infinity.

Instead of disagreeing and using other talking points (which I agree with) why not just accept reality.
This isn't an armageddon thread. Nothing drastic will come of this. Its just going on in the background. And its interesting and people should care about it.

Dear everyone:
Here is some reading to further demonstrate my point:
http://www.iht.com/articles/2007/05/...berg/bxbmw.php
This article explains how BMW will increase production at the Spartanburg plant in the USA as a currency hedge. Someone mentioned this earlier, I agreed with them. Operating a plant in the US uses US$ as its functional currency. Every expense at this plant (wages, rent, etc) is paid for in dollars, and BMW's euro stash can buy more dollars than every before. The more the dollar weakens, the cheaper it is for BMW to buy dollars and operate a US plant. However, this does not negate the weakening dollar 100%. It just helps. At least this move is one without an expiration date (like a hedge). If BMW were to produce 100% of its vehicles in the US there would be no problem. However, as this article states, 2/3 are produced in Germany, while 1/4 are purchased by the USA. Therefore, this expansion plan does not completely offset the problem.

Article 2 (these are all very short so take a look if you care)
http://www.cnbc.com/id/21009863
Quote from article: "Moreover BMW's margins have steadily eroded in recent years, which the company has mainly attributed to the strong euro and rising raw material costs."

I even used the actual word 'eroded.' How ironic. I also argued that producing the E92 will be more expensive than the E46 due to raw material inflation. Also confirmed.
If BMW hedged and did all of these things you guys are arguing about, why have their margins "steadily eroded"????

Now, lets quantify the "erosion":
Same Article 2:
Quote: "The declining value of the dollar and the yen wiped €666 million, or $906 million, from profit last year at the car maker. "

Thats right, $906 million. Yes, some portion of this resulted from the yen, but since the situation with the Yen is identical to that of the US$, it all goes to show that you cannot perfectly hedge currency risk. Period.

These are the first two articles I found from our beloved Google btw. I did not selectively choose those which corroborate my position.

Now that we have established that the US$ has indeed eroded BMW's profits, can we talk about the logical consequences.

BMW can:
1)Increase the sales price of BMW's in the USA. (our beloved M3)
2)Accept eroded profit margin, decreased return on equity, and a stagnant stock price. (I don't think so)(fiduciary responsibility to the shareholders)
3)Accept eroded profit margin, increase debt leverage (risky) to maintain desired ROE. (risk? No one wants risk. The shareholders do not want to hold a risky stock. Now they will demand higher returns to compensate them for higher risk. Or, BMW stock will drop in value. (more likely)
4)Accept eroded profit margin, increase asset turnover (tough) to maintain desired ROE. (magically cycle thru inventory much quicker than before)(dont think so)
5)Cut Costs. Streamlining and cutting the fat are great for any company. However, cutting costs usually carries over to output quality. Do you want to accept a decrease in build quality? (of course not, which is why you will pay higher prices to maintain the same level of quality - see point #1)
6)Produce American consumed cars IN America.(they are trying this)(it will help but not solve 100% of the problem)
7)Tons more options which you have hinted at or I am not smart enough to identify. But they all revolve around higher prices to americans if you think about it.

@GeriFix (the Australian) who pays a ridiculous amount of money for a BMW. I am sorry. That sucks. I did not start this thread to portray Americans as victims. We are fortunate in so many ways its not even funny. $2.88 for a gallon of gas? Last time I checked our European counterparts are paying $8.

[paulyd]

Originally Posted by Seth_Horwitz

This would be true for a futures contract, but a currency swap can be set up with any termination date that you like. Regardless, with either instrument, the gain from the previous hedge would offset the new levels that you must pay. (Good or bad)

For example, at T0, BMW enters into a swap at the current market rate with a notional amount equal to their expected sales over the period, because they feel the exchange rate is good for the bottom line. This swap costs nothing up front, at T0, and has no value either. (You have agreed to pay the current rate, and the rate hasn't changed, so it's not worth anything.)

After the swap has ended, at T1, let's say that the dollar has weakened, and the swap has moved in BMW's favor. This swap is now worth $1B, or whatever number you make up, and BMW is paid in cash. You are correct in that BMW must now enter into a new swap, at the less favorable exchange rate that now exists at T1, BUT, BMW has just been paid in cash the exact dollar amount that offsets their new "loss" by the exchange movement.

For all intents and purposes, BMW is still in a swap with the rate provided at T0, because they have the cash payment from the termination of the first swap. This process can continue forever, with one caveat. This analysis assumes that the swap notional (or amount hedged) is constant over time. This won't be the case, so you are right to assume that their locked in exchange rate will change, but extremely slowly. Basically, the unexpected increase in BMW sales in 5, 10, or 20 years, will have exposure to exchange risk, but the beginning notional amount can carry on forever at the first rate.

The only exchange risk, is for the amount that is not hedged. The hedged amount is locked in due to a series of termination payments that are made at the end of each swap, just before rolling into a new one. When you factor in these payments with the new more or less desirable exchange rates, the net result is the original swap rate.

You sound very knowledgeable, and since I am not a hedge fund manager, I don't want to get burned. But if you are claiming that swaps will protect exchange rate risk indefinitely, I disagree. As soon as swaps expire(and need to be rolled over) the new (lower rates) take effect, going forward.

I am fully aware that the swap payment compensates BMW for the drop which has occurred during the period of the contract. I agree with you. But once it 'rolls over' as you say. BMW must accept the new going rate. I explained this is a previous post. The swap saved them the decline for this year, but for next year they can only protect themselves against FURTHER decline. In year two of operations, no swap payment will protect them from the decline which already occurred in year one and was settled. During year 2, the new currency forward will only protect them from ADDITIONAL decline. The hedge saved them the loss during year 1, but now the lower rate from the end of yr 1 is the going rate for them. This is difficult to explain and probably even more difficult to read. I apologize if that was unclear.

I made a quick excel to convince myself of what I am saying.(see below)
Take a look and tell me what you think.
I started with exchange rate of 0.9 at the beginning of Yr1. At the beginning of each year, BMW enters a swap contract to be paid at year end.
At the end of Yr 1, the rate did not fall. BMW converts 10,000 us$ revenue into 9,000 euros, and the swap is worthless to both parties.
In Yr 2, a new swap contract is formed payable at the end of Yr 2. The rate drops from 0.9 to 0.8. BMW collects less from our purchase (8k instead of 9k) but the swap contract pays then (1k). The end result is that BMW is just as well off in Yr2 as they were in Yr1.
However, in Yr 3 things will catch up to BMW. New swap is entered on Jan 1 of Yr 3 payable at the end of Yr 3. Rate drops from 0.8 to 0.7. BMW collects less euros for each of our dollars paid (7k instead of 8k) and again is paid the difference of the drop from 0.8 to 0.7, which is worth 1k euros. The end result is 8k euros. (not 9k euros.) They have lost 1k of euros in Yr 3 because they had to accept 0.8 exchange rate rather than former 0.9. The swap protected them from further deline to 0.7. But they are still out 1k, which is the difference between 0.8 and 0.9. In other words, the swap raised their effective rate from 0.7 to 0.8, but not all the way back up to 0.9.
Yr 4 same thing happens.

As you can see by the color coded cells, hedging only delays the inevitable by a period of one year. BMW's revenue with the hedge(far right column) starts dropping one year later than it would have, had they not hedged(4th column). If the swaps were for 2 yrs, then BMW would have to face reality 2 yrs after they would have without the hedges.

As soon as swaps are rolled over, the new rate on that day takes hold.

Keep in mind, this is assuming they perfectly hedge the amount of revenue they collect, which is impossible. Secondly, you say there is no cost to a currency swap, which is technically true - except that if the exchange rate goes the other direction, BMW is paying someone else $1billion! Not to mention predicting the amount of the swap is extremely complicated and requires complex software and many highly-trained financial experts(who must be paid a salary). In the end, while options cost money for the right to act, swaps cost money in the event that you guess wrong. Furthermore, option cost is limited to the cost of the option, while swaps have a limitless potential loss.

The only way a hedge would protect BMW from all consequences, is if the period of the hedge was long enough, that they could re-structure(increase investment in the USA) in the time before the hedge expires. And they would have had to 100% accurately predicted the amount of swap needed.(which is impossible given multiple countries of operation, offsetting exchange rate fluctuations, human error, intercompany transactions, supplier functional currencies, etc)

Until somebody explains how hedging costs nothing, and prevents all losses indefinitely, I continue to maintain that companies will suffer to some extent. I have cited several articles now explaining exactly that.

[Seth_Horwitz]

Originally Posted by chitown08

As soon as swaps expire(and need to be rolled over) the new (lower rates) take effect, going forward.

You are correct in that all swaps are entered into at current market rates, but ignoring the fact that the notional amount of the new swap will move as a direct result of these changes in rates, in effect locking in the original exchange rate. I apologize for not using your example, but I figured it would be easier to start from scratch.

Let me begin by saying that I am not trying to be a know-it-all, and just went through creating this example because your logic made me question myself. (Don't tell my boss or I'll get fired, as we engage in swaps every day, but of the Interest Rate variety, not Exchange Rate.)

Rather than taking my word for it, download the Zipped Excel workbook. You can see that you can change the exchange rates at any period, even making the dollar stronger if you like, and it will have no impact on the locking in of the initial exchange rate.

To keep the original rate, you simply need to enter the new swap, at the new rate, with a notional amount equal to your net payments received (or paid) to date. This ignores the Bid/Ask spread on exchange rates, but that spread is extremely minimal in large currency transactions.

By the way, the amount hedged (100, below) is the total dollar amount to be hedged, and has nothing to do with the year it is earned.

[SD330i]

wow I think this thread has gone deeper then any thread I have seen.

I agree with the core principles you state.

[Seth_Horwitz]

Sorry. I quoted the exhange rate backwards in Dollars/Euro, but like I mentioned, you can enter any numbers at all for the exchange rates, and the ending net result will always be the rate at Time0.

[paulyd]

Originally Posted by Seth_Horwitz

You are correct in that all swaps are entered into at current market rates, but ignoring the fact that the notional amount of the new swap will move as a direct result of these changes in rates, in effect locking in the original exchange rate. I apologize for not using your example, but I figured it would be easier to start from scratch.

Let me begin by saying that I am not trying to be a know-it-all, and just went through creating this example because your logic made me question myself. (Don't tell my boss or I'll get fired, as we engage in swaps every day, but of the Interest Rate variety, not Exchange Rate.)

Rather than taking my word for it, download the Zipped Excel workbook. You can see that you can change the exchange rates at any period, even making the dollar stronger if you like, and it will have no impact on the locking in of the initial exchange rate.

To keep the original rate, you simply need to enter the new swap, at the new rate, with a notional amount equal to your net payments received (or paid) to date. This ignores the Bid/Ask spread on exchange rates, but that spread is extremely minimal in large currency transactions.

By the way, the amount hedged (100, below) is the total dollar amount to be hedged, and has nothing to do with the year it is earned.

haha, props man. Didn't think anyone would go this far with me.

Ok, you have pointed out a very important point which had not occurred to me, but you messed up your spreadsheet (I do believe). And I believe your argument only works so long as the dollar keeps falling. Once it stops falling, the swap contracts will be worth nothing, and BMW cannot rely on it to pay them the difference. They will be stuck with the current exchange rate and swap contracts which paid them zero. Your argument that all you need to do is increase the notional amount assumes that BMW can perfectly predict how much further the dollar will devalue in the next contract period. I am convinced you will see my point if you spend a few more minutes. Your spreadsheet only works because the dollar keeps falling in your scenario.

Once the dollar stops falling, BMW will not realize any gain on the swap (and will be stuck converting whatever amount of dollars they have into euros at the market (low) rate, and will not benefit from an offset with any swap gains, because the exchange rate did not fall any further.(rendering the swaps worthless)

The other problem is indirectly caused BMW's revenue to increase each year by the amount of the notional swap contract. This ruins your conclusion.
Ok, check it out. Your Row 16: "Dollars Held" is the notional amount of the swap. It is important that it increases like you say. The fact that you used it to calculate the the Swap Value($) in the row below (Row 17) is also accurate. It accurately portrays the value of the swap given the notional amount of the contract.
Here is the problem. When you sum these two figures together for purposes of translating into Euros (Row 21) you have misused Row 16. Row 16 is the notional value of the swap. It is not the amount of revenue that BMW receives in US$ from sales in the USA.
This is very tricky. I made the assumption on my sheet, that BMW US sales are $10,000 per year. (In your case $100) But, you are changing this assumption and using the notional amount of the swap also as the amount of sales revenue. (You are accidentally increasing the US$ sales revenue each year to match the notional amount of the swap)(From $100 to $102.78 to $114.58). Hopefully this will make sense to you when you read this. Because of this problem, the concluding effective rate is incorrect.

The way you increasing BMW's revenue by accident is incorrect.

Just think about it this way:
2 Parts:
1) BMW gets $100 revenue US$ each year. They need to convert these 100 dollars into Euros. They do so at the current rate, whatever it is. If the rate has gone down, they then get less Euros.
2) BMW engages in swap contract for $100. It pays them the difference between the old (higher) rate, and the new (lower) rate. It thereby exactly offsets the change for that year.

You are correct in the theory that in Yr 2, BMW can then increase the nominal amount of the swap - so that if the dollar continues to drop, the swap gain will not only pay for this years decrease, but also cover Yr 1 decrease. HOWEVER, this is impossible to execute if you think about it. In order to do so, BMW would have to know how much further the rate will fall in order to know how much of a nominal (notional) swap contract to form. Furthermore, it assumes that the rate will continue to fall at all! As I said, if it didn't fall any further (which will inevitably happen) then the swaps would be worthless from that point forward.

I attached your example corrected for BMW's revenue stream, which stays at $100 throughout.

I also attached my example, and modified it to show you what your were trying to say, but messed up. And I also added Yr5, where the us$ stops falling and stays at 0.6. As you can see, in that year, BMW's income all the sudden drops to 6,000 euros. So that you can see what I did in my example: I increased my swap amount from 10,000 in yr 2, to 20,000 in yr 3 and then 30,000 in yr 4. By increasing the amount of the swap contract like this (and the fact that my rate conveniently drops by 0.1 each period), BMW can remain at a level of 9,000 euros of Income.(As I said earlier however, this would be impossible to execute because BMW could not predict that it would fall another perfect 0.1 next period, so they would not KNOW to contract for 20,000 and then 30,000.

And finally, the real killer. In my example below, I added Yr 5. In Yr 5 the value of the dollar stops dropping, and BMW collects ZERO from the swap. All they have is the $10,000 of US$ income which must be converted at the rate of 0.6, which yields them income of 6,000 euros. Which is 3,000 euros less than they had been maintaining thru the use of swaps. That is the end game.

Let me know what you think if you ever have the time to chug thru this. I thought you had me at first but now I believe I have reinforced my position even further.

Either way, cheers

[paulyd]

Originally Posted by SD330i

wow I think this thread has gone deeper then any thread I have seen.

I agree with the core principles you state.

Yes, this is an insane thread. I thought the regression analysis of ring times was impressive....

The saga has continued with my most recent post. Still think I am right that you cannot hedge into eternity. It only delays the inevitable. The only way you could perfectly hedge is if you created a swap contract for the exact amount you needed (impossible), and before the swap expired, you transferred enough of your production into the USA to completely offset future losses by exporting vehicles produced in the US to overseas.(since each BMW euro can buy more US$ thereby making it cheap for them to operate in the US)

We are the only three posting in this thread. Everyone else is like wtf

[Seth_Horwitz]

I'm back again. The only "error" in the spreadsheet was that the $100 on the bottom was not directly linked to the input on top. That's immaterial, though. If you look at the first and second rows, they should be summed. The first row contains the actual dollars that you held/hedged when the new hedge period started (which assumes the same amount when the period ends) and the second row is the value of that hedge at the end of the swap. That's why the next period always starts with the sum of the previous notional and swap. You can even change the exchange in a period so that the dollar gets richer, and this will result in a negative value for your swap in that period, still netting out to your original exchange rate.

Again, I am talking about hedging a specific notional amount for eternity, which has no relation to increases or decreases in BMW sales. They can hedge $1T if they want, but then they would be playing the exchange rate market more than they are hedging against exchange risk. BMW probably figures they will make $X amount of dollars over the next five years, and then sets up a swap leaving some wiggle room. I guess you're just going to have to trust me that the formula is correct. If you do, you will see that strengthening the dollar will still end in the same result. Any combination going up and down will still net the same real rate on the beginning T0 notional amount. However, BMW is likely to terminate the Swaps and hedges when they see sustained growth, "going naked" exchange risk, so they can reap the benefits of the strong dollar. When they feel it's peaked, they should enter into a new swap and lock that rate in for a while. I wish they made such a trade when the Euro came out and then our cars could have been 50% cheaper.

This whole discussion has veered from directly influencing the cost of a car, as raw materials costs, as well as any other commodity priced in dollars, have probably hurt them more than the direct exchange risk. Those items can be hedged as well. My simple point is that an exchange rate (of dollars to euros, cost of steel, cost of oil, ...) can be locked in for eternity (slight exaggeration) as long as you have capital on hand to make the necessary margin calls when a swap goes negative. As the notional goes up, the potential margin call goes up. This is the only thing that stops you from hedging against all income that you are going to make for 100 years. You can do it, but you better have some serious cash on hand if the bank comes 'a callin' after the dollar strengthens.

[paulyd]

Originally Posted by Seth_Horwitz

I'm back again. The only "error" in the spreadsheet was that the $100 on the bottom was not directly linked to the input on top. That's immaterial, though. If you look at the first and second rows, they should be summed. The first row contains the actual dollars that you held/hedged when the new hedge period started (which assumes the same amount when the period ends) and the second row is the value of that hedge at the end of the swap. That's why the next period always starts with the sum of the previous notional and swap. You can even change the exchange in a period so that the dollar gets richer, and this will result in a negative value for your swap in that period, still netting out to your original exchange rate.

Again, I am talking about hedging a specific notional amount for eternity, which has no relation to increases or decreases in BMW sales. They can hedge $1T if they want, but then they would be playing the exchange rate market more than they are hedging against exchange risk. BMW probably figures they will make $X amount of dollars over the next five years, and then sets up a swap leaving some wiggle room. I guess you're just going to have to trust me that the formula is correct. If you do, you will see that strengthening the dollar will still end in the same result. Any combination going up and down will still net the same real rate on the beginning T0 notional amount. However, BMW is likely to terminate the Swaps and hedges when they see sustained growth, "going naked" exchange risk, so they can reap the benefits of the strong dollar. When they feel it's peaked, they should enter into a new swap and lock that rate in for a while. I wish they made such a trade when the Euro came out and then our cars could have been 50% cheaper.

This whole discussion has veered from directly influencing the cost of a car, as raw materials costs, as well as any other commodity priced in dollars, have probably hurt them more than the direct exchange risk. Those items can be hedged as well. My simple point is that an exchange rate (of dollars to euros, cost of steel, cost of oil, ...) can be locked in for eternity (slight exaggeration) as long as you have capital on hand to make the necessary margin calls when a swap goes negative. As the notional goes up, the potential margin call goes up. This is the only thing that stops you from hedging against all income that you are going to make for 100 years. You can do it, but you better have some serious cash on hand if the bank comes 'a callin' after the dollar strengthens.

I'm telling you, you're wrong.

The 102.78 dollars is the amount of the swap. It is a forward contract. It yields the amount of swap gain as you have listed ($11.81)
But your problem is that you then convert both the 102.78 AND the 11.81 into Euros. However, BMW does not 'hold' $102.78, it is just the notional amount of the swap. All that happens is they get paid $11.81 in US$.
Last years income of $100 raw revenue plus $2.78 swap gain has already been converted to Euros in BMW's hands.
They now hold
1) 69.44 euros NOT $102.78 US$.
2) A swap (forward contract) of $102.78, which using your rates will pay them $11.81 at yr end.

The 69.44 Euros from last year is already booked to retained earnings and is invested or spent or whatever.
They don't have $102.78 in US$ hiding under a mattress somewhere. If they did, you'd be correct. But they don't

At T2 in your example.
BMW will collect $100 US$ revenue from US sales of the M3.
They will convert this to Euros at the current rate. (low)
They will also be paid $11.81 from the dealer of the swap forward contract.

They now have $111.81 US$ and it needs to be converted to Euros.
You are converting $114.59 into Euros.

You just magically invented $2.78 like I said in the previous post.

The only way for an extra $2.78 to be created is for BMW to increase their revenue per vehicle sold in the US

Which is ironically what I have been claiming this whole time.
How does BMW create an extra $2.78 of revenue?

The raise the price to us Americans!

I'm telling you, you're wrong. Think about it.
You're confusing the notional rollover with the future cash inflow.

All in good fun of course. I am learning too, but ur still wrong. I promise.
Just read what I just wrote and play thru the cash flow in your head. They get $100 US$ revenue(not $102.78), and they get $11.81 swap gain.