Question

In: Finance

You own a US company with borrowings from Switzerland. Over the next few months, your loan...

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 rate = 0.9796 CHF/USD

Option Premia: Strike Price	Call Option	Put Option
0.9850	0.0108	0.0146
0.9900	0.0087	0.0175

Each option contract has a size of 125,000 Swiss Francs.

Expert Solution

Alternative 1: No hedge

If no hedge is taken then borrower will be exposed to risk when USD deprciates against CHF as more USD will be needed to purchase CHF 50 mil when payment is due. Payoff will be as follows.

Spot Rate	$m
0.9738	51.35
0.9788	51.08
0.9838	50.82
0.9888	50.57
0.9938	50.31
0.9988	50.06
1.0038	49.81

Hence, this strategy is not recommended.

Alternative 2: Forward hedge

It will lock in the cost for the borrower. However, if USD appreciates against CHF, borrower still has to pay agreed USD to purchase 50 million CHF (i.e. 0.9796 CHF/USD or 1.0208 USD/CHF). Payoff will be as follows.

Spot Rate	$m (Spot)	$m (Forward)	Profit/Loss ($m)
0.9738	51.35	51.04	0.30
0.9788	51.08	51.04	0.04
0.9838	50.82	51.04	-0.22
0.9888	50.57	51.04	-0.47
0.9938	50.31	51.04	-0.73
0.9988	50.06	51.04	-0.98
1.0038	49.81	51.04	-1.23

As you can observe, when USD appreciates against CHF, borrower has to suffer losses due to pre locked in cost. This strategy is recommended when borrower expects USD to depreciate against CHF.

Alternative 3: Bear Call Spread

This strategy is useful when the borrower expects USD to depreciate against CHF. We are long on 0.9850 call and short on 0.9900 call.

Spot rate	Long Call (0.9850)	Short Call (0.9900)	Premium Paid ($m)	Premium Received ($m)	Profit/Loss ($m)	Profit/Loss ($m)	Net Profit/Loss ($m)
0.9738	Exercised	Expired	0.55	0.44	0.58	-	0.48
0.9788	Exercised	Expired	0.55	0.44	0.32	-	0.22
0.9838	Exercised	Expired	0.55	0.44	0.06	-	-0.04
0.9888	Expired	Expired	0.55	0.44	-	-	-0.11
0.9938	Expired	Exercised	0.55	0.44	-	-0.19	-0.30
0.9988	Expired	Exercised	0.55	0.44	-	-0.44	-0.55
1.0038	Expired	Exercised	0.55	0.44	-	-0.69	-0.80

As you can observe, borrower is in profit when USD depreciates but incurs losses when USD appreciates. However, here the loss is reduced compared to no hedge.

jeff jeffy answered 2 years ago

An investor is very confident that a stock will change significantly over the next few months;...

An investor is very confident that a stock will change significantly over the next few months; however, the direction of the price changes is unknown. Which pair of strategies is most likely to produce a profit if the stock price moves as expected? I. Short butterfly spread 2. Bearish calendar spread 3. Long at-the-money straddle 4. Short strangle A. 2 and 3 b. 2 and 4 C. 1 and 4 D. 1 and 3

James Company expects the following sales in the next few months: Month &nb

James Company expects the following sales in the next few months: Month Units Selling Price July 50,000 $ 8.10 August 80,000 $ 8.10 September 40,000 $ 8.60 October 30,000 $ 8.60 James expects to collect 60 % of sales in the month of sale, 30 % in the following month, 5 % in the next month, with 5 % remaining uncollected. Required: Prepare a schedule of cash receipts for September and October.

Jane Company expects the following sales in the next few months: Month &nbs

Jane Company expects the following sales in the next few months: Month Units Selling Price July 50,000 $ 8.10 August 80,000 $ 8.10 September 40,000 $ 8.60 October 30,000 $ 8.60 Jane expects to collect 60 % of sales in the month of sale, 30 % in the following month, 5 % in the next month, with 5 % remaining uncollected. Prepare a schedule of cash receipts for September and October.

You own 100% of your company. You negotiate a $500,000 Convertible Debt Loan from an Angel...

You own 100% of your company. You negotiate a $500,000 Convertible Debt Loan from an Angel group. It is convertible Debt loan from an Angel group. It is convertible into stock when you raise your next equity round, and will convert at a price which is a 25% discount to the next round's premoney valuation. It has a Cap of $7m on the Conversion Valuation. A year later, you raise your first equity round at a premoney valuation of $8m....

A US company has ordered watches from Switzerland that will require a payment of Swiss francs...

A US company has ordered watches from Switzerland that will require a payment of Swiss francs (CHF) 500,000 in three months. The expected spot prices to prevail in three months range from $1.00 to $1.12. The following information is available: Spot rate $1.06/CHF 3-month forward rate $1.07/CHF Interest rate in US5.00% Interest rate in Switzerland2.00% Call option premium$0.040E=$1.06 Put Optionpremium$0.045E=$1.06 How can the firm hedge using forward rates? Show the payoffs for the expected spot rates. How can the firm...

A company is planning its production schedule over the next six months (it is currently the...

A company is planning its production schedule over the next six months (it is currently the end of month 2). The demand (in units) for its product over that timescale is as shown below: Month 3 4 5 6 7 8 Demand 5000 6000 6500 7000 8000 9500 The company currently has in stock: 1000 units which were produced in month 2; 2000 units which were produced in month 1; 500 units which were produced in month 0. The company...

Fast forward a few months...Your friend asks you how your business is doing and you are...

Fast forward a few months...Your friend asks you how your business is doing and you are unsure how exactly to answer. In fact, you are not necessarily sure how your business is going since you are so new to this! This part will help you organize your thoughts and come up with a more formalized process and financial reporting can help you demonstrate your success (or lack thereof!). For your cart, come up with a way to determine profit and...

Over the next few years economist expect that the next financial bubble might be the high...

Over the next few years economist expect that the next financial bubble might be the high debt of organizations bursting. A. Explain the difference between highly leveraged firms and low leveraged firms in regards to fixed and variable costs B. What are the benefits of being highly leveraged and the downfalls. C. Explain the benefits of being low leveraged firm and the potential downfalls.

GG Pearl Corp. is a large multinational firm. Over the next two months, the Company is...

GG Pearl Corp. is a large multinational firm. Over the next two months, the Company is expecting to have sales in Europe totaling 500,000,000 Euros, and is also expected to make purchases from vendors in Europe totaling 350,000,000 Euros. The Company is concerned about the volatility in the exchange rates of currencies in which it has transactions, so it has instituted a policy to mitigate exchange rate risk. GG Pearl's hedging policy is as follows: 50% of the net notional...

Assess your business: Fast forward a few months... Your friend asks you how your business is...

Assess your business: Fast forward a few months... Your friend asks you how your business is doing and you are unsure how exactly to answer. In fact, you are not necessarily sure how your business is doing since you are so new to this! This part will help you organize your thoughts and come up with a more formalized process and financial reporting can help you demonstrate your success (or lack thereof!). For your cart, come up with a way...