In: Finance
Trident is a US company that sells goods to crown, a
British firm in March for Sterling pounds 1,000,000. Payments are
due in three months that is June. Trident cost of capital is 12%.
The following quotes are available:
a. spot exchange rate: $1.7640/pound
b. Three month forward rate: $1.7540/pound
c. UK 3 month borrowing interest rate is 8% p.a (or 2% per
quarter)
d. US 3 month rate is 8% p.a (or 2% per quarter)
e. US 3 month investment rate is 6% p.a (1.5 per quarter)
June put options on the stock exchange of 12,500 pounds, strike
price is $1.75; 1.5% per pound premium, and brokerage cost $25 per
contract.
June put option in the OTC market 1,000,000 pounds; strike price is $1.75; 1.5% premium. Trident foreign exchange adviser forecasts that the spot rate in 3 months will be $1.76/pound.
REQUIRED
i. Remain unhedged position
ii. Hedge in the forward market
iii. Hedge in the money market
iv. Hedge in the capital market
Summary:
The above question seeks to test the students knowledge in both the areas of foreign currency management and the hedging techniques that a financial planner of a company could evaluate before proceeding with a particular option. Though the question only asked to evaluate the options, I have taken the liberty to even include the proposal that shall be considered in the light of the information provided in the question. Further, hedging in capital market is shown only via stock exchange as cover via stock exchange is more standardized than that of the OTC market. However, cover via OTC has been added in the notes below the final answer.