Question

Assume that Carbondale Company expects to receive S$500,000 in one year. The existing spot rate of the Singapore dollar is US$0.70. The one-year forward rate of the Singapore dollar is US$0.72. Carbondale created a probability distribution for the future spot rate in one year as follows:

Future Spot Rate	Probability
US$0.68	20%
0.73	50%
0.77	30%

Assume that i) one-year put options on Singapore dollars are available, with an exercise price of US$0.73 and a premium of US$0.04 per unit and ii) one-year call options on Singapore dollars are available, with an exercise price of US$0.70 and a premium of US$0.03 per unit. Assume the following money market rates:

	U.S.	Singapore
Deposit Rate	2%	8%
Borrowing Rate	3%	9%

Given this information, evaluate the use of forward hedge, money market hedge, a currency options hedge. Which hedge is most appropriate and why? Consider the possibility of not hedging, what do you recommend?

Answer 1