Question

A U.S. firm has a payable of 125,000 Swiss francs in 90 days. The current spot rate is $.6698/SFr and the 90 day forward rate is $.6776/SFr.

90 day call option on SFr:      strike=$.68, premium=$.0096

90 day put option on SFr:       strike=$.68, premium=$.0105

Interest rates                           US       Switz.                          Possible spot rate in 90 days

90 day deposit rate                 3%     3%                             Spot                Probability

90 day borrowing rate             3.2%    3.2%                            $.65                 10%

                                                                                                $.67                 20%

                                                                                                $.69                 70%

______________________________________________________________________

Calculate the expected dollar cost of the payable for each of the following:

(1) FORWARD HEDGE

(2) MONEY MARKET HEDGE

(3) OPTION HEDGE(S)

(4) REMAINING UNHEDGED

Should the firm hedge? If so, how? Consider both cost and risk in your decision.

Answer 1

a).

Forward Hedge = Payable amount x Forward rate
= 125,000 SFR x $0.6776
= $84,700

b).

Money Market Hedge:
Present value of SFR = 125000 / 1.03 = 121,359.22
Spont rate of this amount = 121,359.22 / 0.6698 = 81,286
Amount to be paid = $81,286 x 3.2% = $2,601
Total $ cost payable = $81,286 + $2,601 = $83,887

c).

Expected price = (0.65 x 10%) + (0.67 x 20%) + (0.69 x 70%) = 0.07 + 0.13 + 0.48 = 0.682

Profit = ($0.682 - $0.68) x 125,000
= $0.002 x 125,000
= $ 250

$ payable cost = $0.682 x 125,000
= $85,250

Total $ cost = $0.0096 x 125,000 = $1,200

Total $ amount payable on the call option = $85250 + $1200
= $86,450

Reducing the profit form total $ cost = $86,450 - $250
= $86,200

Expected price = (0.65 x 10%) + (0.67 x 20%) + (0.69 x 70%)
= $0.07 + $0.13 + $0.48
= $0.682

$ payable cost = $0.682 x 125,000
= $85,250

$1,312 + $85,250 = $86,562

Total $ amount payable on the put option = $85000 + $1200 = $86,312

d).

$ cost = 125,000 x $0.682 = $85,000

When the firm remains unhedged, this will pay as an expected amount of $85,000 at the ending period of 90 days.