9) John Deere Manufacturing has just signed a contract to sell agricultural equi

Question

9) John Deere Manufacturing has just signed a contract to sell agricultural equipment to Bosch, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, John Deere is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. Use this information to a) Explore several possible hedge strategies b) Propose the best one for John Deere under the given circumstances ? The spot exchange rate is $1.4050/euro ? The six month forward rate is $1.4550/euro ? Cost of capital is 11% ? The annual Euro zone 6-month borrowing rate for the firm is 9% ? The annual Euro zone 6-month lending rate for the firm is 7% ? Their annual U.S. 6-month borrowing rate is 8% ? Their annual U.S. 6-month lending rate is 6% ? December put options contract for euro 625,000 has a strike price of $1.42, premium price is 1.5% ? Their own internal forecast for 6-month spot rates is $1.43/euro ? Their budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro

Explanation / Answer

Plains States could hedge the Euro receivables in the money market. Using the information provided, how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate?

A)$1,250,000

B)$1,724,880

C)$1,674,641

D)$1,207,371

Answer:B

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