From: thornley@milli.cs.umn.edu (David H. Thornley)
Subject: Re: Js Need for LH SP (Was Schofield...)
Organization: University of Minnesota, Minneapolis, CSci dept.
Distribution: na
Date: Mon, 25 Jan 1993 20:25:56 GMT

In article <kbanaian.201.0@bernard.pitzer.claremont.edu> kbanaian@bernard.pitzer.claremont.edu (King Banaian) writes:
>In article <C1A8M4.Dp3@news2.cis.umn.edu> thornley@milli.cs.umn.edu (David H. Thornley) writes:
>>In article <kbanaian.189.0@bernard.pitzer.claremont.edu> kbanaian@bernard.
>
>>>[The Expos and Jays can cover themselves against exchange rate changes
>>> by buying futures contracts.]
>>
>>You can do this on a short-term basis, and weather a short spell of bad
>>exchange rates, for a price.  For the long run, the Jays and Expos will
>>get large chunks of Canadian money, and pay out large chunks of US
>>money, and there's limits to how much insurance they can buy (or afford).
>>
>I agree that it is more costly to cover long-term contracts.  How the Jays 
>will cover the last year of Carter's contract is difficult.  But the forward 
>market and futures market would have no difficulty with a two-year horizon, 
>and longer forward market hedging is probably available (albeit it at a 
>fairly stiff premium).  Moreover, since that cost is known in advance, they 
>will factor the premium into Carter's contract and thus reduce the offer 
>they make to him.  The exchange rate risk is assigned in the contract for 
>Joe's services, just as it would be if the U.S. were exporting oranges to 
>Canada.
>
I'm not looking at the span of Carter's contract so much as the whole
picture.  The Jays and Expos, like any business, have revenues and expenses.
In this particular case, their revenues are largely in Canadian dollars and
their expenses are primarily in U.S. dollars.  If the Canadian dollar goes
up relative to the U.S. dollar, their revenues go up relative to their
expenses, and they make more money.  If the Canadian dollar goes down,
they make less money.  This is similar to a trucking firm; if the highways
are unusually safe, they have fewer accidents and make more money; if the
highways are unusually dangerous, they have more accidents and make less
money.

Companies can buy insurance for both adverse currency variations and truck
accidents.  What this does is transform a potential large loss into an actual
small loss.  It doesn't make the problem magically go away.  If a small
trucking firm has two trucks totalled in a week, it's a real good thing if
they're properly insured, but if they lose trucks consistently their insurance
rates will rise to more than cover the cost of replacing/repairing the trucks.
Similarly, the Jays can insure (OK, "hedge") against a declining Canadian
dollar in the short term, but if the Canadian dollar stays down there isn't
much they can do.

In the case of a two-year contract, they can easily buy a futures contract
that will give them the right to buy enough U.S. money at a given exchange
rate, but that's an extra expense to them, and hence a competitive
disadvantage, since no other team in the American league (and only one in
the National) has the same uncertainty.  Therefore, suppose they want to
hedge Carter's contract - they're paying a large chunk of money for the
privilege of paying Carter megabucks, and that can't help.

This assumes, of course, that the Canadian dollar is likely to stay down.
If it doesn't, the Jays would be well off to buy maybe a year's worth of
hedging to cover short-term fluctuations, but nothing's going to protect
them against the long-term fluctuations.

After all that, of course, we must remember that exchange rates are only
one factor in profitability, and that most teams have bigger variances
than the exchange rate.  The Jays, of course, are probably basically the
richest team in baseball, and can well afford a competitive disadvantage
or two.  The Expos are not so lucky.

David Thornley
"this space for rent - philosophers preferred"