Question

Saturn Industries sells its products under a licensing agreement to many parts of the globe. Under the terms of an agreement reached with a German company, a payment for Saturn’s services is due in one year for 1 million euros. There is some concern over the value of the euro in one year, as the Canadian dollar has been strengthening.

The spot rate is 1.3805 Canadian dollars for one euro, but the one-year forward rate is 1.3676 Canadian dollars for one euro. Currently, interest rates are 3 percent in Canada and 4 percent in Germany for one year. There is also a belief within the firm that the spot rate in one year will be 1.3825 because the euro is due to get stronger.

a-1. Calculate the receipts if Saturn Industries takes a chance on the spot rate. (Enter the answer in dollar, and not in millions.)

Receipts $

a-2. Calculate the receipts if Saturn Industries books a forward contract. (Enter the answer in dollar, and not in millions.)

Receipts $

a-3. Calculate the receipts if Saturn Industries buys a money market hedge. (Do not round intermediate calculations. Enter the answer in whole dollar, and not in millions.)

Receipts $

Answer 1

Saturn Industries sells its product, bill is 10,00,000 euros due in one year.

(1) Answer

Receipts on spot rate

bill is 10,00,000 euros due in one year.

Spot rate within one year is 1.3825 canadian dollars for 1 euro

Therefore receipts =10,00,000 euros * 1.3825= $ 1382500.

(2)

If Saturn Industries books forward contract

One year forward rate is 1.3676 canadian dollars for 1 euro

Receipts = 10,00,000* 1.3676= $1367600.

(3)

If money market Hedge

then forward rate shall be =1.3805 (1+0.03)/ (1+0.04) = 1.3672 per Euro

Then Receipt on forward = 10,00,000* 1.3672 = $1367200.

a. If Saturn Ind. takes chance of spot then, Loss due to money market hedge

Receipts as per spot rate is $ 1382500 Less receipts as per forward is $ 1367200

Loss = $15300.

b. If spot rate Unchanged i.e current spot rate then loss is

Receipts as per spot rate is $ 1380500 Less receipts as per forward is $ 1367200

Loss= $13300.