In mid-September your firm had a foreign currency obligation to pay £5 million in mid-September 2016. You were asked to assist in hedging the exchange rate risk. At the time you gathered the following information:
- Spot exchange rate in mid-September (S0): $1.5705/â‚¤.
- 360-day forward (F360) quotes for the pound in September: $1.5095 - 04/â‚¤.
- Eurocurrency rates from a large bank:
Term U.S. dollar pound sterling
12-month borrowing rate 2.000% p.a. 6.050% p.a.
12-month deposit rate 1.850% p.a. 5.948% p.a.
- The Sep 2016 futures price at market opening at the time in mid-September 2015 was $1.5099/â‚¤. Each contract is for â‚¤62,500.
- Relevant option market information in September 2015 was:
Strike Call Put Expiration
15300 6.57 2.50 September 2016
- Assume that in mid-September 2016 when the payment is received the spot exchange rate is $1.6200/â‚¤.
- i. If you hedged in the forward market:
- a. What currency did you buy or sell in the forward market?
- b. What would be your net dollar cost in September 2016 using the forward hedge?
- c. Compared to the do-nothing option, what would be the exchange rate gain/loss in September 2016 from hedging with the forward?
- ii. If you hedged in the futures market:
- a. Did you buy or sell futures contracts?
- b. What would be the profit/loss on the futures market transaction in September 2016?
- c. What would be your net dollar cost in September 2016 considering the futures hedge?
- iii. If you hedged using options:
- a. Did you buy/sell calls or puts?
- b. What would be your net dollar cost in September 2016 considering the options hedge?
- c. Relative to the do-nothing option, what would be your exchange rate gain or loss in September 2016 from using options?
- iv. If you hedged using a money market hedge:
- a. What would be your dollar cost in September 2016 using the money market hedge?
- b. What exchange rate would you lock in?
This question belongs to international finance and discusses about foreign currency obligation.
Word count: Excel format
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