5. You own a US company with borrowings from Switzerland. Over the next few mont
ID: 2816990 • Letter: 5
Question
5. You own a US company with borrowings from Switzerland. Over the next few months, your loan repayment of CHF 50 million is due. Given the foreign exchange market movements, you would like to minimise the impact on your cash outflow. Based on the following data, devise a suitable strategy. Evaluate your chosen strategy against suitable alternatives for a range of expected future spot rates. Spot rate 0.9888 CHF/USD 3 month forward rate 3 month future rate0.9796 CHF/USD Option Premia: Strike Price 0.9850 0.9900 Call Option 0.0108 0.0087 Put Option 0.0146 0.0175 Each option contract has a size of 125,000 Swiss Francs.Explanation / Answer
Call Option contracts are to be taken as the money is required in CHF after 3 months.
Number of contracts needed = CHF 50,000,000 / CHF 125,000
= 400.
Amount in $ at spot rate = CHF 50,000,000 / 0.9888
= US $ 50,566,343.04
For entering into forward contracts, first we need to pay as per the 3 month forward rate and the options premia.
Considering, first type forward contract,
Amount to be paid for 3 month forward rate.
US Dollars required after 3 months = CHF 50,000,000 / 0.985
= US $ 50,761,421.32
Amount to be paid for Options = 400 * 0.0108
= US $ 4.32
Total cash outflow = 50,761,421.32 + 4.32
= US $ 50,761,425.65
Considering, second type forward contract
Amount to be paid for 3 month forward rate.
US Dollars required after 3 months = CHF 50,000,000 / 0.99
= US $ 50,505,050.51
Amount to be paid for Options = 400 * 0.0087
= US $ 3.48
Total cash outflow = 50,505,050.51 + 3.48
= US $ 50,505,053.99
Since, total cash outflow is least in case of second type of option contract, it is best to go for that.
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