DLK (U.S.A.) recently signed a contract to sell pharmaceutical products to Apex
ID: 2802997 • Letter: D
Question
DLK (U.S.A.) recently signed a contract to sell pharmaceutical products to Apex Medicals, a Malaysian distributor of drugs, for MYR 40,000,000. [MYR = Malaysian ringgit] The sale was made in March with payment due 9 months later in December. Because this is a sizable contract for the firm and because the contract is in MYR rather than USD, DLK 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:
Spot rate = USD 0.24 / MYR
Forward rate = USD 0.22 / MYR
DLK’s forecasted rate = USD 0.20 / MYR
Malaysian borrowing rate = 10% per year
Malaysian lending rate = 8% per year
US borrowing rate = 4% per year
US lending rate = 3% per year
DLK’s WACC = 5% per year
Dec put options on MYR: Strike price = 0.24/USD, premium is 1.8%
DLK chooses to hedge its transaction exposure in the forward market at the available forward rate. The payoff in 9 months will be ________.
A. USD 8,000,000Explanation / Answer
Since currency is hedged at forward rate of 0.22 USD/MYR, Payoff in 9 months = Forward rate* payment due
= 0.22* 40,000,000
= $8,800,000
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