International Finance

Just need answers for 2 following questions. Please show all work.

 

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1. Super Hero Corporation based in the US sold a fleet of their latest Hover Flying Suits to the Ministry of Defense in London on credit for £45,000,000 payable in 9 months.

 

Nine-month forward exchange rate: F9 = $ 1.6933 / £

Fx Advisor estimated spot rate in nine months: ST = $ 1.4585 / £

 

(a) What is the expected gain/loss from forward hedging?

(b) If you were the financial manager of Super Hero, Inc., would you recommend hedging this pound receivable? Why or why not?

(c) Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you recommend hedging in this case? Why or why not?

(d) Suppose now that the advisor forecasts the future spot exchange rate to be $ 1.7276 / £. Would you recommend hedging? Why or why not?

 

2. You plan to visit Germany in six months to negotiate a retail contract with a company located in Munich. You expect to incur a total cost of € 10,800 for lodging, meals and transportation.

 

Current spot exchange rate: $0.70 / €

Six-month forward rate: $0.78 / €

Six-month call option on euros has exercise rate: $0.82 / €

Premium on six-month call option: $0.03 / €

Expected future spot exchange rate: same as the forward rate

Six-month interest rate in U.S.: 3.5% per annum

Six-month interest rate in Germany: 1.5% per annum

 

(a) Calculate your expected dollar cost of buying €10,800 if you hedge via a call option on euros.

i. First calculate the FV of the call premium

ii. Next, at the expected future spot rate would you exercise the option?

iii. To find your expected dollar cost: If you would not exercise, then total expected dollar cost is the FV of the premium plus the cost exchanged at the future spot rate. If you would exercise the option, then the total expected dollar cost would equal the FV of the premium plus the cost exchanged at the option exercise price.

(b) Calculate the future dollar cost of meeting this euro obligation if you hedge using a forward contract.

(c) At what future spot exchange rate will you be indifferent between the forward and option market hedges?

(d) Illustrate the future dollar costs of meeting the euro payable against the future spot exchange rate under both the options and forward market hedges. Graph “$ Cost” on the Y-axis and “$ / €” on X-axis.

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