ork Week 8 ork must be shown in order to receive credit HEDG

ork Week 8 ork must be shown in order to receive credit. HEDGING RECEIVABLES A firm will receive SF 200,000 in one year. Assume the US Forward rate on SF rate of SF is 5o 50.0 s0.50 $0.025 Put is available with exercise Premium for the put Premviam for the call is A) It the firm uses a money market hedge, how much will at receive (in USD) in 1 year? They wit receive SF, f they borrow SF now, they can use the receivobles to pay off the loan They will take the SF received from the loan, invest it in the us and the amount they have in 3 year is the amount the effectively receive on the payables 8) If the firm uses a forward hedge, how much will it receive lin USD) in 1 year? C) Now let\'s look at using options (use the data in the aboue table o wel the firm use a call or a put opsion? Premium EMective price for each SF $amount received n L r Prohability of tach if an option is used under for200,000 SF when Probability So Total amount expected if using options esed on the sbowe scenarios, how much would the fires expect to receve WITHOUT eo,000 without | Prob, weighted ased on

Solution

The Exchange Risk can be hedged by using the following strategies:

A.Money Market Hedge:

Borrow SF convert to $,invest $ ,repay SF loan with 1-yr receivables

Amount in SF$ borrowed at =SF 200000/(1+.4800)

                                        =SF $ 135135.13

$ received from converting SF $ at spot rate =SF $ 135135.13 *$.48 per SF

                                                                =$64864

Since the interest rate in US is 6% for 1 Yr period.

$ accumulated after 1 year =$64864 *(1+.06)

                                       =$68756.

There fore the amount receivables from money market hedge is $ 68756.

B.Forward Contract :

Calculation of the cash flows receivable from forward contract is as below:

The cash flow from receivables =Receivables in SF *1-year Forward Rate

                                              =SF 200000*$.485/SF

                                              =$97000

There fore the amount receivable from the foward contract is $97000

C.

	Option Contract
	Scenario	Spot Rate in 1-yr	Premium /unit paid for the option	Exercise option	Received per unit after premium	Total Dollars received from converting SF$ 200000	Probability
	Scenario 1	$0.48	$0.03	Yes	$0.45	$90,000.00	30%
	Scenario 2	$0.50	$0.03	No	$0.47	$94,000.00	60%
	Scenario 3	$0.54	$0.03	Yes	$0.51	$102,000.00	10%
	Cash to be received
		($90000*.3+$94000*.6+$102000*.1)
		$27000+$56400+$10200
		$93,600
	From the above it is interpreated that the cash flow highest is received in case of forward contract is highest which is $97000
D	Calculating the cash flows if receivables are unhedged as follows:
	Cash Flow	Receivables * Exchange Rate
		SF 200000*($.48*.3+$.5*.6+$.54*.1)
		$99,600
	Since the unhedged cash flow position is less than the forward contract hedge of cash flow of $97000 the firm should hedge its receivables.