HEDGING STRATEGY

Hedging Strategy

Hedging Strategy

Company Background

Columbia River Pulp Company owned and operated a world class Kraft market pulp mill located in Longview, Washington. The mill began production in 1980, after a two year construction period, and had a rated annual capacity of 385,000 metric tonnes of bleached hardwood and softwood pulp. Output from the mill was sold to paper products manufacturers in the United States, Mexico, Europe and Japan. CRP was recognized as having a favorable cost structure, reliable production record and excellent quality of output. In April 1987, a major consulting firm to the forest products industry estimated the mill's replacement value at $400 million, based on the depreciated value of a 10 year old facility.

Kraft market pulp was a principal input in the manufacturing of high quality paper products, including writing paper and envelopes, boxboard and tissue. The “kraft” process involved cooking or “digesting” wood chips in a chemical solution of caustic soda and sodium sulfide at high temperature and pressure. The resulting pulp, which looks similar to brown porridge, was then bleached to a bright white color using a five-stage chlorine process. The chemical breakdown of the wood fibres in the kraft process, as opposed to a mechanical grinding breakdown, produced a longer, stronger fibre required for high quality paper.

Kraft market pulp producers, such as CRP, sold their output on the open market, as compared to captive or integrated producers who shipped output to affiliated paper mills. Kraft pulp was a global commodity with price being a function of overall economic activity, industry capacity and the amount of output “dumped” on the market by integrated producers. Price levels for market pulp were extremely volatile and caused dramatic swings in the earnings and cash flow of industry participants, as shown in Exhibits 1 and 2.

Introduction

This report is to check the hedging strategy that was used and lead to the huge loss of Columbia River Pulp Company and point out the importance of managing foreign exchange exposure through select appropriate hedging strategies. The huge loss of Columbia River Pulp Company and its cause is discussed in the first part. The importance of hedging and the tools of hedging are respectively reviewed in part two and part three. Finally, suggestions are given out on how to design proper hedging strategies for different enterprises.

Options to the firm

Recapitalization Financing 225 ,000 ,000

Conditions

Interest Rate Swaps or Hedging Arrangements must b made within 90 days of closing .A interest rate not to exceed 12 percentNote: term of at least 3 years is insurance for the lender Scheduled Repayment (in 28 quarterly installments beginning first quarter after 7-21-88:Installments1-201.75 each Installments21-275.00 each Final Installment2830 Prepay is allowed.Estimated interest rate and inflation forecast:6.38 low to 7.96 high 7.0 low to 9.0 high 8.5 low to 9.0 high 8.5 low to 8.6 high 8.7 low to 9.0 high 9.2 low to 10.0 high

CRP estimates that it will be able to prepay between 11 and 23 million in each of the next 7 ...