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For each of the following company transactions, indicates whether the company in question should purchase forward...

For each of the following company transactions, indicates whether the company in question should purchase forward contract, sell forward contract, purchase a call option, or purchase a put option, or none, to limit its exposure to exchange rate risk. Answers can be more than one.

a. A U.S. MNC, Independent Bank, will receive interest payments denominated in Colombian peso.

b. A U.S. MNC, Merged Co. will sell inventory software applications to Mexico denominated in Mexican peso.

c. A U.S. MNC, Bahamas Inc., will purchase Canadian papers and the contract is denominated in U.S. dollars.

d. A Singapore MNC, Tema Inc., may have projects in Thailand that needs funds in Thailand Baht. The company is in the bidding process and outcome is not known yet.

Solutions

Expert Solution

a. A U.S. MNC, Independent Bank, will receive interest payments denominated in Colombian peso : sell forward contract or purchase a put option

Since interest payments to be received are denominated in Colombian peso, the Bank wants to hedge against a fall in the value of the Colombian peso, therefore the bank should either sell forward contract (enter into an obligation to sell the currency at the forward rate locked in) or purchase a put option (have a right, but not an obligation, to sell the currency at a specific price if the exchange rate falls below the specific price)

b. A U.S. MNC, Merged Co. will sell inventory software applications to Mexico denominated in Mexican peso. : sell forward contract or purchase a put option

Merged Co. will receive payment in Mexican peso for the sale of inventory software applications to Mexico, and therefore will want to hedge against a fall in the value of the Mexican peso.

c. A U.S. MNC, Bahamas Inc., will purchase Canadian papers and the contract is denominated in U.S. dollars : None or no hedging

Bahamas Inc. will purchase Canadian papers and will make payment in U.S. dollars which is the company's home currency. Since payment will be made in the home currency US dollars there is no exposure to exchange rate risk to the company. Hence, no hedging is required.

d. A Singapore MNC, Tema Inc., may have projects in Thailand that needs funds in Thailand Baht. The company is in the bidding process and outcome is not known yet. : purchase a call option (right, but not obligation, to purchase the currency at a specific price)

Tema Inc. may need funds in Thailand Baht, and hence might have to purchase Thailand Baht in order to fund the projects in Thailand. Therefore it will want to hedge against a rise in the value of the Thailand Baht.

Since the company is in the bidding process and outcome is not known yet therefore it should not purchase a forward contract because doing so will create an obligation on the company to purchase Thailand Baht at the agreed forward rate.

jeff jeffy answered 2 months ago
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