Question

ABC is a company that just bought goods from a french company for 500 million euros with payment due in 4 months. Assume the following:

Spot rate $1.30/euro

4 month forward rate $1.31/euro

4 month french interest rate 8% pa; US 6% pa

4 month call option on euros at a strike price of $1.29/euro with a 3% premium

4 month put option on euros at a strike price of $1.305/euro with a 4% premium

Questions:

1, The proceeds of the forward market hedge are?

2. The proceeds of the money market are?

3.The future value of the appropriate premium is?

4. Breakeven exchange rate between forward market hedge and your option alternative?

Please show how you got the answers so I can understand

Answer 1

Answer:1

Proceeds of the forward market hedge = Cost of Goods purchased / Forward Rate

                        = 500 Mn / 1.31

                        = $ 381.679390

Answer:2

Proceeds of the money market hedge:

Convert 500 Mn € to P.V i.e,

500mn / [1 + (8%/4)] = € 490.196

Note: If € 490.196 is invested today at the French Interest Rate for 3 months, the maturity value will be exactly = € 500 Mn which is the amount of payable.

To buy € 490.196, it will incur:
$384,615,384.62 = € 500,000,000/1.3.
The cost of fulfilling = $384,615,384.62 as of today.

Answer:3

Future of appropriate premium = 1.3 x [(1 + 8% / 3) / (1 + 6% / 4)]
                                                 =$1.3085 as compared to per €

Answer:4

Breakeven exchange rate between forward market hedge and your option alternative =

1. Forward Rate – Option 1 Rate

= 1.31 – (1.29 + 0.03) = -0.01

2. Forward Rate – Option 2 Rate

= 1.31 – (1.29 + 0.04) = -0.02