Baker Adhesives Case Study

It took Doug Baker some time to get over his disappointment. If international sales were the key to the future of Baker Adhesives, however, Baker realized he had already learned some important lessons. He vowed to put those lessons to good use as he and Moreno turned their attention to the new Novo order.

Note that the loan from the bank affiliate was a 26% annual percentage rate for a three-month loan (the bank would charge exactly 6.5% on a three-month loan, to be paid when the principal was repaid). The effective rate over three months was, therefore, 6.5%. The 8.25% rate for Baker's line of credit was an annual percentage rate based on monthly compounding. The effective monthly rate was, therefore, 8.52% / 12 = 0.71%, which implies a (1.0071)3-1 = 2.1452% effective rate over three months.

After some discussion and negotiation with the bank and bank affiliates, Moreno was able to secure the following agreements: Baker Adhesives' bank had agreed to offer a forward contract for September 5, 2006, at an exchange rate of 0.4227 US$/BRL. An affiliate of the bank, located in Brazil and familiar with Novo, was willing to provide baker with a short-term real loan, secured by the Novo receivable, at 26%.2 rate o Baker's domestic line of credit; however, the bank described Brazil's historically high inflation and the recent attempts by the government to control inflation with high interest rates. The rate they had secured was typical of the market at the time.

Rather than eliminate exchange risk through a contracted future exchange rate, a firm could make any currency exchanges at the known current spot rate. To do this, of course, the firm needed to convert future expected cash flows into current cash flows. This was done on the money market by borrowing "today" in a foreign currency against an expected future inflow or making a deposit "today" in a foreign account so as to be able to meet a future outflow. The amount to be borrowed or deposited would depend on the interest rates in the foreign currency because a firm would not wish to transfer more or less than what would be needed. In this case, Baker Adhesives would borrow in real against the future inflow from Novo. The amount the company would borrow would be an amount such that the Novo receipt would exactly cover both principal and interest on the borrowing.