Question

Narto Co. (a U.S. firm) exports to Switzerland and expects to receive 200,000 Swiss francs in one year. The one-year U.S. interest rate is 5% when investing funds and 7% when borrowing funds. The one-year Swiss interest rate is 9% when investing funds, and 10% when borrowing funds. The spot rate of the Swiss franc is $.80. Narto expects that the spot rate of the Swiss franc will be $.75 in one year. There is a put option available on Swiss francs with an exercise price of $.79 and a premium of $.02.                                                                       

a. Determine the amount of dollars that Narto Co. will receive at the end of one year if it implements a money market hedge.

b. Determine the amount of dollars that Narto Co. expects to receive at the end of one year (after accounting for the option premium) if it implements a put option hedge.

Answer 1

Funds are borrowed in swis fran and invested in US
	Funds borrowed	=200000/(1+10%)	181,818
	These funds are converted to USD @ 0.80=	= 181818*0.8	145,454
	These funds are invested in US @ 5%	145454*(1+5%)	152,727
	So in money market hedge the funds received are US $ 152,727
Options
	Required options to be puchased	200000*0.02	4000
	These funds are borrowed in US so payable after 1 year	4000*(1+7%)	4280
	Funds received after 1 year	200000
	exchange rate in options	0.79
	Funds converted	200000*0.79	158,000
	Less option premium		(4,280)
	Net receipt		153,720