Question

Instruction 10.1:
Use the information for the following problem(s).

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 Won7,500 million. Won1,000 million has already been paid, and the remaining Won6,500 million is due in six months. The current spot rate is Won950/$, and the 6-month forward rate is Won975/$. The six-month Korean won interest rate is 8% per annum, the six-month US dollar rate is 6% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A six-month call option on won with a 1,000/$ strike rate has a 2.0% premium, while the six-month put option at the same strike rate has a 1.4% 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 is 12%. Compare alternate ways that Bobcat might deal with its foreign exchange exposure. What do you recommend and why?
										Assumptions		Values
					Purchase price of Korean manufacturer, in Korean won		7,500,000,000
					Less initial payment, in Korean won		(1,000,000,000)
					Net settlement needed, in Korean won, in six months		6,500,000,000
Current spot rate (Won/$)		950
Six month forward rate (Won/$)		975
Bobcat's cost of capital (WACC)		12.00%
Options on Korean won:		Call Option		Put Option
Strike price, won		1,000.00		1,000.00
Option premium (percent)		2.000%		1.400%
		United States		Korea
Six-month investment (not borrowing) interest rate (per annum)		6.000%		8.000%
Borrowing premium of 2.000%		2.000%		2.000%
Six-month borrowing rate (per annum)		8.000%		10.000%

1 .Refer to Instruction 10.1. If Bobcat chooses to hedge its transaction exposure in the forward market, it will ________ won 6,500,000,000 forward at a rate of ________.

A sell; won975/$

B sell; $950/won

C buy; won975/$

D buy; won950/$

2. Refer to Instruction 10.1. What is the cost of a call option hedge for Bobcat's won payable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.)

A $145,053

B Won136,842

C $136,842.

D Won145,053

Answer 1

Q - 1

The correct answer is option C buy; won975/$

It will have to long (buy) a forward contract at the curretn 6 months forward price.

Q - 2

Cost = Settlement Amount / Spot rate x Call premium = Won 6,500,000,000 / (Won 950 / $) x 2% = $ 136,842

Hence, cost on future dollars = Cost in dollars today x (1 + WACC x t) =  136,842 x (1 + 12% x 0.5) = $ 145,053

Hence, the correct answer is the first option i.e. option A. $ 145,053