Question

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 Won7,700million.​ Won1,000 million has already been​ paid, and the remaining Won6,700 million is due in six months. The current spot rate is Won 1,111​/$, and the​ 6-month forward rate is Won1,161​/$. The​ 6-month Korean won interest rate is 16​% per​ annum, the​ 6-month U.S. dollar rate is 3.5​% 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 3.6​% ​premium, while the​ 6-month put option at the same strike rate has a 2.9​% 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 11.5​%.

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

Won1,111​/$?

Won1,161​/$?

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​/$? To be Won1,300​/$?

e. What do you​ recommend? a) A money market Hedge b)unhedged position. c)forward market hedge. d)option market hedge

Answer 1

		[Currencies in Millions]
a)	Amount payable at Won 1,111 = 6700/1111 =	$                 6.031
	Amount payable at Won 1,161 = 6700/1161 =	$                 5.771
b)	Amount payable under the forward hedge = 6700/1161 =	$                 5.771
c)	Under the MMH, Bobcat has to set up a WON liability that will
	be equal to 6700 m Won in 6 months.
	For that it will have to borrow 6700/1.09 =	6146.789	Won
	The Wons so borrowed should be converted into $ at spot to get 6146.789/1111 =	$                 5.533
	Those $s should be invested to get after 6 months 5.533*1.0175 =	$                 5.629
	The final receipt would be the above amount of	$                 5.629
d)	If the Won is less than 1200/$, the put option would not be exercised.
	The receipt on exercise would be 6700/Spot rate after six months.
	The net receipt would be 6700/Spot rate-FV of option premium.
	If the Won is 1300/$, the put option would be exercised.
	Amount receivable on exercise = 6700/1.200 =	$        5,583.333
	Less: FV of option premium = 5583.333*2.9%*(1+0.115/2) =	$            171.227
	Net amount receivable under the put option	$           5,412.11
e)	The forward hedge is recommended as it has the highest confirmed
	receipt.
	The unhedged position is risky, as the future rate could be anything.