Question

You are importing new coffee makers from Germany.  You will have to pay 2 million euros for the next shipment in 90 days.  The current spot price of the euro is 1.1735 $/euro, and the 90-day euro forward rate is 1.1737 $/SF.  Note, euro futures and options are for 125,000 SF per contract.  

Future Values Table:

	5% depreciation in euro, $/euro = ____	No Change in spot rates, $/euro = 1.1735 in 90 days	5% appreciation in euro, $/euro = _____
Value of 2 million euro payable
Value of ___ futures contracts
Sum of futures plus payable
Value of ______ (number and type) Options
Sum of options plus payable
Money Market Hedge

a) Calculate the $/euro exchange rates for a 5% appreciation and depreciation of the euro in the top row.

b) Finish filling in the second row; show how much in dollar terms the euro payable will be worth to your company given changes in the euro (note the sign).  

c) Enter (as a positive or negative) the number of futures contracts you plan to buy or sell to fully hedge your exposure in the euro.  Ignoring interest from marking-to-market, fill the 3^rd row with future values of these contracts (be careful).  What will be your total future value (including the receivable) under each scenario given this transaction?  Put that in the labeled row.

d) Instead of hedging your exposures with futures, you consider hedging with options.  Enter in the first column the number and type of options you plan to use to fully hedge this exposure.  Assume options with a 1.17 strike price maturing in 90 days currently cost 1.3 cents per euro.   Further, assume that the WACC of your company is 9% per year.  Fill in each of the future values.  What will be your total future value (including the payable) under each scenario given this transaction?  Put that in the labeled row.  Does your company do better with an appreciation or depreciation if you use this hedge?

Answer 1

Answer to sub part (a):

$/Euro Exchange Rate if Euro depreciates by 5%:

• Current Spot Price is : 1 Euro = 1.1735 $
• If Euro depreciates by 5%, it will take 5% less $ to make up for a Euro.
• Therefore, if Euro depreciates by 5%, then the price of Euro = 1.1735 $ * 0.95 = 1.1148 $.
• Answer if Euro depreciates: $/Euro Rate = 1.1148.

$/Euro Exchange Rate if Euro appreciates by 5%:

• Similarly, if Euro appreciates by 5%, then the price of Euro = 1.1735 $ * 1.05 = 1.2322 $.
• Answer if Euro appreciates: $/Euro Rate = 1.2322.

Answer to sub part (b):

Value of 2 million Euro in $ terms payable in 90 days:

-> If the Euro depreciates by 5%, then the rate will be 1.1148 $/Euro.

Therefore, value in $ terms = 2 million Euro * 1.1148 = $2,229,600

-> If there is no change in spot rate , then the rate will be 1.1735 $/Euro.

Therefore, value in $ terms = 2 million Euro * 1.1735 = $2,347,000

-> If the Euro appreciates by 5%, then the rate will be 1.2322 $/Euro.

Therefore, value in $ terms = 2 million Euro * 1.2322 = $2,464,400