Spot U$0.7506/C$ Spot $0.008156/¥ Dec FWD U$0.7513/C$ Mar FWD $0.008173/¥ U$ Int

Question

Spot                 U$0.7506/C$                           Spot                 $0.008156/¥

Dec FWD         U$0.7513/C$                           Mar FWD         $0.008173/¥

U$ Interest Rates

Borrow: 3.25% Invest: 3.00%

C$ Interest Rates                                              Japanese ¥ Interest Rates

Borrow: 2.7% Invest: 2.4%                             Borrow: 1.5% Invest: 1.2%

Options:                                                           Options:

Call:     X = $0.75        C = $0.01                     Call:     X = $0.0082/¥ C = $0.0002/¥

Put:      X = $0.75        P = $0.01                     Put:      X = $0.0082/¥ P = $0.0002/¥

1.         Suppose your firm is owed an account receivable of C$1,000,000 due on Dec. 23, 2015.

Treat this as a one-month hedge. Show how you would hedge this debt with:

a)         a money market hedge (use appropriate borrowing and lending rates),

b)         option contracts (use the borrowing rate to carry the cost forward),

c)         forward contracts.

d)         What would your hedging results (ending cash flows) be if the spot rate on Dec 23

were U$0.73/C$?

e)         if U$0.74/C$?

f)         if U$0.75/C$?

g)         if U$0.76/C$?

h)         if U$0.77/C$?

i)          What if you had gone unhedged with the ending spot rates for d, e, f, g, and h?

j)          Graph the results for ending spots of U$0.73/C$ through U$0.77/C$.  

k)         Which approach do you think would be best?

2.         Suppose your firm has an account payable ¥12,500,000 due on Mar 25, 2016 (4 months)

Show how you would hedge this payable with:

a)         a money market hedge (use appropriate borrowing and lending rates),

b)         option contracts (carry premium cost forward at borrowing rate),

c)         a forward contract.

e)         What would your hedging results (ending cash flows) be if the spot rate on Mar 25, 2016 were $0.0078/¥?

f)         if $0.0080/¥?

g)         if $0.0082/¥?

h)         if $0.0084/¥?

i)          if $0.0086/¥?

j)          What if you had gone unhedged with the ending spot rates for e, f, g, h, and i?

k)         Graph the results for ending spots of $0.0078/¥ through $0.0086/¥?  

l)          Which approach do you think would be best?

Explanation / Answer

Money Market Hedge:

Investment rate in C$ = 2.7/12 = 0.225%

          After 1 month, the firm has to pay C$1000000. This payment should be made using the export proceeds.

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