In: Finance
The following problem is similar in format and nature to previous assignments and/ or practice problems.
Answers should be submitted with all “work shown”. Provide a verbal explanation/description of your answers.
Submissions graded on the basis of: content (arriving at the correct answers), fully explaining the reasoning/logic upon which the anwers are based, grammar & writing, and basic “quality of presentation”. See the top of Modules for examples of high quality presentation, writing, and general “upper-level university” submissions.
PROBLEM: Assume that the transactions are hypothetical transactions, (a – e), by imaginary U.S. firms that have no other foreign transactions. Place an “X” in the table wherever you see possible ways to hedge each of the transactions. Below the table, provide an explanation on HOW/WHY the hedge would be effective. No math needed, just logical reasoning. Xs alone are not sufficient, you must briefly describe "how/why" the action would be effectively used.
a. Simmons Co. plans to purchase Japanese goods denominated in yen.
b. Calk, Inc., will sell goods to Japan, denominated in yen.
c. Kelly Corp. has a subsidiary in Australia that will be remitting funds to the U.S. parent.
d. Black, Inc., needs to pay off existing loans that are denominated in Canadian dollars.
e. Austin Co. may purchase a company in Japan in the near future (but the deal may not go through).
***** You will need to use either Word or Excel to create a table, then put checks or Xs into the correct response(s).
Forward Contract Futures Contract Options Contract
Forward Purchase Forward Sale Buy Futures Sell Futures Purchase a Call Purchase a Put
a.
b.
c.
d.
e.
Forward Purchase | Forward Sale | Buy Futures | Sell Futures | Purchase a Call |
Purchase a put |
|
a. | X | |||||
b. | X | |||||
c. | X | |||||
d. | X | |||||
e. | X |
Explanation:
a. Simmons has to pay the transaction in Yen. So they need to buy yen in market by entering in to forward contract by fixing the price today. They hedge because yen may rise in future.
b.Clarke will receive Yen as their payment. Clarke will hedge the risk of yen because Yen may fall hence by locking in today's price to convert yen to dollars.
c. Parent will receive Australian dollars. They will enter in to forward sales of Australian dollars and buying US dollars. The hedge is because Australia dollar may fall in value.
d.To pay off loan company needs Canadian dollars. Hence forward purchase of Canadian dollars by fixing the price today, fearing that it may increase in value.
e. Uncertain that deal may not go through. Hence this risk can be hedged using purchase of call option. Call option holder have rights but not obligation to execute. For the rights call option holder pays the premium.