In: Finance
Bobcat Company. Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was Won 7,800 million. Won1,000 million has already beenpaid, and the remaining Won 6,800 million is due in six months. The current spot rate is Won 1,105/$, and the 6-month forward rate is Won1,106/$. The 6-month Korean won interest rate is 16.5% perannum, the 6-month U.S. dollar rate is 3% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A 6-month call option on won with a Won1,200/$ strike rate has a 3.3% premium, while the 6-month put option at the same strike rate has a 2.7%premium.
Bobcat can invest at the rates given above, or borrow at 2% per annum above those rates. Bobcat's weighted average cost of capital is10%.Compare alternate ways below that Bobcat might deal with its foreign exchange exposure.
a. How much in U.S. dollars will Bobcat pay in 6 months without a hedge if the expected spot rate in 6 months is assumed to be Won1,105/$? Won1,160/$?
b. How much in U.S. dollars will Bobcat pay in 6 months with a forward market hedge?
c. How much in U.S. dollars will Bobcat pay in 6 months with a money market hedge?
d. How much in U.S. dollars will Bobcat pay in 6 months with an option hedge if the expected spot rate in 6 months is assumed to be less than Won1,200/$? To be Won 1,300/$?
e. What do you recommend?
a) Without hedge, if the expected spot rate in 6 months is Won 1105/$ then the Bobcat will pay 6800/1105= $6.1538 million
Similarly, if the rate is Won 1160/$ then Bobcat will pay 6800/1160=$5.8621million
b) Forward market proceeds= 6800/1106=$6.1483 million
c) Firstly, Present value of Won 6800 million has to be found out. The rate of interest is 16.5% per annum. So for 6 months it is 8.25%.
So the present value = Won 6800 million/1.0825= Won 6281.7552
That means if the company invests Won 6281.7552 million now, it will be able to pay Won 6800 million after 6 months.
Dollar cost for buying Won 6281.7552 million = 6281.7552/1105=$5.6848 million
If the company borrows this amount, then it is at 5% per annum (borrowing rate is 2 % above). That means 2.5% for 6 months.
So the net amount including interest is 5.6848*1.025=$5.8269 million
d) Call option premium= 0.033*6800 million =Won 224.4 million= $2.0308 million
Its future value after 6 months= $2.0308*1.015= $2.0613 million
If the future spot rate is less than Won 1200/$ then Bobcat will exercise the call option and buy 6800 Won.
Won 6800 million @1200/$ is $5.6666 million
So, total dollar cost= $5.6666+$2.0613=$7.7279 million
If it is Won 1300/$ then there will be a premium loss of $2.0613 million additionally.
e) So, by looking on to alle these options, money market hedge is the best way in which the company spends less amount. So we can recommend the company to go ahead with money market hedge.