Derivatives
Answer 1)
In case, the company use 90-day forward contract, it will be required to pay:
=300000*(0.40)
= $120000
On the other hand, if it go by money market hedge, initially, it will invest:
=300000/1.03
= 291262 ringits
In other words, in order to accumulate 300000 ringits in 90 days, the firm will need to deposit 291262 ringits presently. Henceforth, the firm will need to borrow, 291262* 0.404= $117,670 in the spot market.
The borrowed amount will be paid after 90-days with 4% interest, and this compute to:
= 117,670*(1.04)
= $122,377
Therefore, by using the money market hedge, firm will need to pay $2377 more than the forward hedge. Hence, it should go for the forwar hedge
Answer 2)
Steps to hedge in the money market
a) Borrow, 4000000/1.08= NZD 3703704
b)Convert this amount to USD using the rate of 0.54. Accordingly, the firm will get $2000000
c)Invest $2000000 at 9% for 1 year to accumulate $2180000.
This shows that the money market hedge is more feasible option for the company
Answer 3)
Following the Interest Rate Parity(IRP), forward premium to be received on Pesos should be:
=(1.03/1.04)-1
= -9.65%
Hence, using this premium rate, the forward rate will be:
$.10 × [1 + (–.0965)] = $.09035.
Therefore, in order to hedge 1 million pesos, an amount of 1000000*0.09035= $90,350 will be received
b)
Percentage change in the Mexican peso according to PPP will be:
(1 + .05)/(1 + .04) – 1 = 0.96%.
Therefore, spot rate for PESOS is expected to be:
= $.10 × (1.0096) = $.10096
Henceforth, under the condition of PPP and no hedging, we will receive:
= 1,000,000 × $.10096 = $100,960
c) In the previous calculation, we found that expected spot rate for USD based on the condition of PPP will be $0.10096. Now, since this amount is higher than the exercise price, we will be seling the PESOS at this unhedged rate and not at the exercise price. In this situation, the premium will be $0.014per unit
Answer 4)
Referring to the above calculation, we see that money market hedge and unhedged strategy provide the same cash outflow. Hence, either of them will be feasible option compared to the put option strategy.
Answer 5)
Option A: Money Market Hedge
Under this scenario,Narco Co. should borrow 500,000 Swiss francs to be used to pay off the loan, and then convert it into USD. By converting, 500000/1.11= SF 450,450 into USD $360,360, and the depositing it, the firm will receive $278,378 in one year
Option B: Put option hedge
With the given exercise price of $0.79, Narco should exercise the put option and sell the 500000 SF to get, 500000*0.79= $395000. The premium paid for exercising this option is $10000. Therefore, the net amount expected to be received is (395000-10000)= $3,85,000.
Answer 6)
a) The company has a brand equity and recognition and this could result in sustainable demand for its products. Additionally, the company also has a marketing expertise and economies of scale associated with each store that helps it in keeping the cost low on account of bulk purchase.
b) The risk of the company can possibly decrease on account of international diversification by spreading its store around multinational location and just being dependent on US economic conditions only
c) Possible obstacle in China include different culture, exchange rate risk and partnership with alien distributors
Answer 7)
The annual cost of financing here is determined on the discount rate that equals to the USD payment. Therefore, using excel IRR function, we found that the discount rate here is 8.97% and since this percentage is less that the 12% cost of financing with U.S. dollars, it will be a feasible option for the company. However, in addition to the discounting factor, the firm should also weigh the
expected savings from financing in Singapore dollars with the uncertainty associated with such financing in USD.
Answer 8)
Bill of Lading is a documented proof of shipment that includes summary of all freight charges and convey title to the merchandise
Answer 9)
= (1.70/1.09)-1
= 55.96%
Hence, dollar will be required to appreciate by 55.96% in order for the strategy to backfire.
Answer 10)
a) Assuming the company borrows yen in spot market and simultaneously purchase the yen for one-year forward, it will be required to pay a forward premium that will offset the interest rate differential. Based on the interest rate differential, the forward premium here will be 3.8% and the effective financing rate will be:
(1.05/1.038)-1
= 9%
b) If the company does not cover the exposure and use the forward rate as a forecast, If it does not cover the exposure, but uses the forward rate as a forecast, the expected percentage change in the Japanese yen’s value is about 3.8 percent while the financing rate will be 9%. In this situation, the company should finance with dollars rather than Japanese yen
c)
Possible % Effective Financing
Change in Spot Rate of JY if that
Rate of JY Percentage Change Occurs Probability
5% (1.05)(1.05) – 1 = 10.25% 33.3%
3% (1.05)(1.03) – 1 = 8.15 33.3%
2% (1.05)(1.02) – 1 = 7.10 33.3%
