Question

1. As the CFO, you decided to hedge using forward contracts. Assume that the expected final sales volume is 30,000. What are your total benefit/cost and the percentage benefit/cost from hedging (compared to no hedging)

a) if the exchange rate remains at $1.18/€?

b) if the exchange rate will be $1.3/€?

c) if the exchange rate will be $1.1/€?

d) As the CFO, you decided to hedge using option contracts. Assuming expected final sales volume is 30,000, what are your total benefit/cost and the percentage benefit/cost from hedging (compared to no hedging)

e) if the exchange rate remains at $1.18/€?

f) if the exchange rate will be $1.3/€?

g) if the exchange rate will be $1.1/€?

What is the most profitable strategy for the case in which the expected final sales volume is 30,000 (no hedge, forward contract, or option contract)

h) if the exchange rate remains at $1.18/€?

i) if the exchange rate will be $1.3/€?

j) if the exchange rate will be $1.1/€?

k) Is there a best strategy? Why? Note that you only need to provide a few sentences about which strategy to use from no hedge, forward contract, or option contract strategies.

Answer 1

1	forward contract exchange rate ($/euro) =	1.195
	expected sales	30,000
	cost per student ( in euro)	€                         2,500
	So according to the forward contract the cost in Dollars =	=1.195*2500*30000 = $89,625,000
	So the CFO has to pay	$              89,625,000
	Now we calculate the expected the profit/ loss from this hedging
a.	if the exchange rate =	$1.18/ Euro
	Total cost would have been=	1.18*30000*2500= $88,500,000
	So if he didn’t hedge , he would have to pay	$              88,500,000
	So the loss from hedging	= 88500000-89625000
		$               -1,125,000
	Percentage loss	1125000/88500000=
		-1.27%
b.	if the exchange rate =	$1.3/ euro
	Total cost would have been=	1.3*30000*2500= $97,500,000
	So if he didn’t hedge , he would have to pay	$              97,500,000
	But due to hedging he has to pay-	$              89,625,000
	So the benefit from hedging	= 97500000-89625000
		$                 7,875,000
	Percentage benefit	7875000/97500000
		8.08%
c.	if the exchange rate =	$1.1/ euro
	Total cost would have been=	1.1*30000*2500= $82,500,000
	So if he didn’t hedge , he would have to pay	$              82,500,000
	But due to hedging he has to pay-	$              89,625,000
	So theloss from hedging	= 82500000-89625000
		$               -7,125,000
	Percentage loss	-7125000/82500000
		-8.64%

2.  

2	Option strike price=	$1.17/ euro
	Premium=	1.20%
	Total option cost	1.18
	expected sales	30,000
	cost per student ( in euro)	€                         2,500
	So according to the option contract the cost in Dollars =	=1.184*2500*30000 = $88,800,000
	So the CFO has to pay	$              88,800,000
	Now we calculate the expected the profit/ loss from this hedging
a.	if the exchange rate =	$1.18/ Euro
	Total cost would have been=	1.18*30000*2500= $88,500,000
	So if he didn’t hedge , he would have to pay	$              88,500,000
	So the loss from hedging	= 88500000-88800000
		$                   -300,000
	Percentage loss	300000/88500000
		-0.34%
b.	if the exchange rate =	$1.3/ euro
	Total cost would have been=	1.3*30000*2500= $97,500,000
	So if he didn’t hedge , he would have to pay	$              97,500,000
	But due to hedging he has to pay-	$              88,800,000
	So the benifit from hedging	= 97500000-88800000
		$                 8,700,000
	Percentage benefit	8700000/97500000
		8.92%
c.	if the exchange rate =	$1.1/ euro
	Total cost would have been=	1.1*30000*2500= $82,500,000
	So if he didn’t hedge , he would have to pay	$              82,500,000
	But due to hedging he has to pay-	$              88,800,000
	So the loss from hedging	82500000-88800000
		$               -6,300,000
	Percentage loss	-6300000/82500000
		-7.64%

3.

3	best option:
	if exchange rate = $1.18/euro	No hedge
	if exchange rate = $1.3/euro	options has better profit than forward
	if exchange rate = $1.1/euro	options has less loss than forward
	So options is the best strategy.