Our company has just made a bid today, July 11, 2018, for a service contract in...

Our company has just made a bid today, July 11, 2018, for a service contract in Sweden. Unfortunately, the bid had to be in kronas. The current exchange rate is 8.4 SEK/USD. We will find out by September 10, 2019 whether we won the contract or not. The size of the bid is $10 Million kronas payable on October 1, 2019. The service will be delivered from October 1, 2019 through September 30, 2020. To protect ourselves against exchange rate fluctuations, we buy a European put option with an exercise price of 5.0 SEK/USD on the krona in Philadelphia Exchange for 10 Million kronas with an exercise date October 1, 2019.

Is this an appropriate strategy for us? Explain fully.

Solutions

Expert Solution

European Put buy is bought is to protect any kind of unfavorable movement in the exchange rate. In this case, the company is expecting the payment of $10 million Kronas by October 1, 2019. On October 1, 2019, the company, if they win the contract, needs to exchange the $10 million Kronas. Current exchange rate is 8.4SEK/USD and if the exchange rate goes up to say 10 SEK/USD then company will be receiving few dollars for exchanging the number of Kronas as Kronas has appreciated.

Hence the decision of buying an European Put option at 5 SEK/USD is most appropriate. In case the company wins the contract and exchange rate has appreciated then company can exercise put option . In case, if the exchange rate falls below 5 SEK/USD, then company will not exercise put and will lose only the premium amount. Also in case if the company fails to win the contract then also the company lose only the premium amount paid for options.

Hence in this gain, the amount of loss is limited to the amount of premium paid but the exchange rate risk is hedged in appropriate manner.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

our company has been approached to bid on a contract to sell 5,250 voice recognition (VR)...

our company has been approached to bid on a contract to sell 5,250 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $4 million and will be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $440,000 to be returned at the end...

Calculating a Bid Price Your company has been approached to bid on a contract to sell...

Calculating a Bid Price Your company has been approached to bid on a contract to sell 15,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $3.4 million and will be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $75,000 to be...

a) Your company is bidding for a service contract in a first-price sealed-bid auction. You value...

a) Your company is bidding for a service contract in a first-price sealed-bid auction. You value the contract at $12 million. You believe the distribution of bids will be uniform, with a high value of $16 million and a low value of $3 million. What is your optimal strategy with 5 bidders? b) Your company is bidding for a service contract in a first-price sealed-bid auction. You value the contract at $12 million. You believe the distribution of bids will...

Problem 8-34 Calculating a Bid Price Your company has been approached to bid on a contract...

Problem 8-34 Calculating a Bid Price Your company has been approached to bid on a contract to sell 3,900 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $3.5 million and will be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $92,000...

Today is 1 July 2018. Matt is 30 years old today. Matt has a portfolio which...

Today is 1 July 2018. Matt is 30 years old today. Matt has a portfolio which consists of three Treasury bonds (henceforth referred to as bond A, bond B and bond C). There are 200 units of bond A, 300 units of bond B and 500 units of bond C. Bond C is a Treasury bond which matures on 1 January 2021. One unit of bond C has a coupon rate of j2 = 3.35% p.a. and a face value...

Today is 1 July 2018. Matt is 30 years old today. Matt has a portfolio which...

Today is 1 July 2018. Matt is 30 years old today. Matt has a portfolio which consists of three Treasury bonds (henceforth referred to as bond A, bond B and bond C). There are 200 units of bond A, 300 units of bond B and 500 units of bond C. • Bond A is a Treasury bond which matures on 1 January 2027. One unit of bond A has a coupon rate of j2 = 2.95% p.a. and a face...

Today is 1 July 2018. Matt is 30 years old today. Matt has a portfolio which...

Today is 1 July 2018. Matt is 30 years old today. Matt has a portfolio which consists of three Treasury bonds (henceforth referred to as bond A, bond B and bond C). There are 200 units of bond A, 300 units of bond B and 500 units of bond C. Bond A is a Treasury bond which matures on 1 January 2027. One unit of bond A has a coupon rate of j2 = 2.95% p.a. and a face value...

A company is trying to decide whether to bid for a certain contract or not. They...

A company is trying to decide whether to bid for a certain contract or not. They estimate that merely preparing the bid will cost $10000.If their company bids, then they estimate that there is a 50% chance that their bid will be put on the “short-list;” otherwise their bid will be rejected. Once “short-listed” the company will have to supply further detailed information (entailing costs estimated at $5000). After this stage their bid will either be accepted or rejected. The...

Cavincare has 50 years remaining on a service contract with Martin, Inc. Today, Martin paid $120,000...

Cavincare has 50 years remaining on a service contract with Martin, Inc. Today, Martin paid $120,000 for services received last year and the annual payment increases by 2.5% each year. The firm’s required rate of return is 15%. What is the value of the contract to Cavincare? (Do not round intermediate calculations. Round the final answer to the nearest whole dollar amount.) a.) $987,131 b.) $980,879 c.) $974,634 d.) $915,000

Curtiss Construction Company, Inc., entered into a fixed-price contract with Axelrod Associates on July 1, 2018,...

Curtiss Construction Company, Inc., entered into a fixed-price contract with Axelrod Associates on July 1, 2018, to construct a four-story office building. At that time, Curtiss estimated that it would take between two and three years to complete the project. The total contract price for construction of the building is $4,240,000. Curtiss concludes that the contract does not qualify for revenue recognition over time. The building was completed on December 31, 2020. Estimated percentage of completion, accumulated contract costs incurred,...

Subjects