Question

In: Operations Management

1. Draw an exposure diagram to illustrate a firm’s exposure to interest rate risk if the...

1. Draw an exposure diagram to illustrate a firm’s exposure to interest rate risk if the firm is going to borrow $10m six months from today. Assume the loan will be a one-year loan with all interest paid at the end of the year. Graph the relation between the firms interest costs and interest rates. Also graph the relation between the firm’s profit and interest rates (assuming that higher interest costs cannot be passed on the consumers).

2.Draw an exposure diagram to illustrate the relationship between a firm’s costs and the exchange rate between US dollar and Euro dollar if the fir plans to purchase goods from an European firm one year from today. Assume that the transaction is denominated in Euro dollar, but that the firm is concerned about its costs in US dollars. Also draw an exposure diagram to illustrate the relationship between a firm’s profit and the exchange rate between US dollar and Euro dollar.

3. Draw an exposure diagram to illustrate the relationship between a gold mining firm’s profit and the price of gold in three months.

4. Would a call option or a put option hedge the exposure of the firms described in problem 1,2 and 3?

5. Would a long (buy) or a short (sell) forward position hedge the exposure of the firms described in problem 1,2 and 3?

Solutions

Expert Solution

As per policy I can answer only 1st 4 subparts if there are many subparts in a question.

Question 1:

Question 2:

If the pound appreciates relative to the dollar, then it will take more dollars to buy pounds, which implies that the firm’s cost in dollars will be higher, hence if the value of the pound rises, the firm costs associated with purchasing the British products will increase and the firms profit will decrease.

Question 3:

Question 4: How to hedge using call\put options.

For question 1 to hedge the firms exposure: Purchase a call option with an underlying asset being the interest rate in six months

For question 2 to hedge the firms exposure: Purchase a call option with an underlying asset being the value of the pound relative to the dollar

For question 3 to hedge the firms exposure: Purchase a put option with an underlying asset being the price of gold in 3 months.

Hit thumbs up if you find this useful.


Related Solutions

Money market hedge can be used to hedge a firm’s translation exposure to exchange rate risk....
Money market hedge can be used to hedge a firm’s translation exposure to exchange rate risk. Is this statement true or false? Why?
1. Describe the interest-rate risk exposure of a bank that in March 2019 made a two-year...
1. Describe the interest-rate risk exposure of a bank that in March 2019 made a two-year $100m term loan with funds raised by 90-day NCDs. 2. Explain how the bank can use futures to hedge this risk, nominating with futures position would be involved Make answers simple! Thank you very much !
An FI is having a positive duration gap. What is the FI's interest rate risk exposure...
An FI is having a positive duration gap. What is the FI's interest rate risk exposure and how can it use financial futures to hedge that risk exposure? The FI can hedge its exposure to interest rate decreases by selling future contracts The FI can hedge its exposure to interest rate decreases by buying future contracts The FI can hedge its exposure to interest rate increases by buying future contracts The FI can hedge its exposure to interest rate increases...
What are whales and horses adapted for? 1. Illuminate (investigate, illustrate {draw, diagram, print}, describe, and...
What are whales and horses adapted for? 1. Illuminate (investigate, illustrate {draw, diagram, print}, describe, and explain) what scientists have discovered regarding the adaptations present in the cranial anatomy of baleen whales including: 1. the very large cranium with “telescoped” cranial and facial bones 2. Adaptations for aquatic breathing and sound generation (nasal opening (blowhole), lungs, air passages, phonic lips, etc.) 3. Adaptations for aquatic hearing (high frequency clicks involved in echolocation (toothed whales only), infrasound (ultra low frequency sound...
Draw an AS/AD diagram to illustrate a decrease in dollar value in the US economy ....
Draw an AS/AD diagram to illustrate a decrease in dollar value in the US economy . Clearly label axes and the current position of AS & AD relative to full employment RGDP....also indicate any shifts that would occur if the exchange rate of the $ rose sharply against other major currencies
Suppose the economy is in a long-run equilibrium. a. Draw a diagram to illustrate the state...
Suppose the economy is in a long-run equilibrium. a. Draw a diagram to illustrate the state of the economy. Be sure to show aggregate demand, short run aggregate supply, and long-run aggregate supply. b. Now suppose that a stock market crash causes aggregate demand to fall. Use your diagram to show what happens to output and the price level in the short run. What happens to the unemployment rate? c. Use the sticky-wage theory of aggregate supply to explain what...
(a)What is exchange rate risk? Distinguish between Transaction Exposure and Economic exposure to exchange rate movements....
(a)What is exchange rate risk? Distinguish between Transaction Exposure and Economic exposure to exchange rate movements.      (b)Consider the following information:             90-day U.S interest rate………………………………………………………….4%             90-day Malaysian interest rate……………………………………………….3%             90-day forward rate for the Malaysian Ringgit ……………………..$0.400             Spot Rate of Malaysian Ringgit ………………………………………………$0.404 Assume a U.S based MNC will need 300,000 Ringgit in 90 days and wishes to hedge this payable position. Would it be better off using a FORWARD hedge or MONEY MARKET hedge?     
In the space below, draw a firm’s isocost/isoquant diagram with K on the vertical axis and...
In the space below, draw a firm’s isocost/isoquant diagram with K on the vertical axis and L on the horizontal axis. Show the change that would occur if capital became more expensive and the firm maintained the same total cost.  Be sure to show how each curve changes.  To the right of the graph, clearly indicatewhat happens to the level of output and use of both L and K, and whether you are showing L and K as substitute inputs or complementary...
What are HORSES adapted for? (page 1) Illuminate (investigate, illustrate {draw, diagram, print}, describe, and explain)...
What are HORSES adapted for? (page 1) Illuminate (investigate, illustrate {draw, diagram, print}, describe, and explain) what scientists have discovered regarding the adaptations/ adaptive complexes present in modern HORSES (genus Equus, horses, zebras) 1. Locomotor system (quadrupedal, functionally monodactyl, unguligrade cursors) 2. Masticatory (chewing) system (cheeks, tongue, jaws, jaw muscles, dentition, etc.) 3.Visual system (eyes: pupil, lense, retina, tapetum lucidum, etc. ALSO: orbit placement, visual field, etc.) 4.Auditory (hearing) system (pinnae {external ears}, ear tube, ear drum, ear ossicles, inner...
1.What is price risk/interest rate risk of a bond? A. The risk of a decline in...
1.What is price risk/interest rate risk of a bond? A. The risk of a decline in a bond’s price due to an decrease in interest rate B. The risk of an increase in a bond’s price due to an decrease in interest rate C. The risk of a decline in a bond’s price due to an increase in interest rate D. The risk of an increase in a bond’s price due to an increase in interest rate E. None of...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT