4) Motion, Inc. a U.S. apparel design firm, owes Mexican Peso 10 million in 30 days...

4) Motion, Inc. a U.S. apparel design firm, owes Mexican Peso 10 million in 30 days in return for shipment of textiles from Mexico. Motion’s treasurer is considering using a currency collar (or range forward) to hedge the company’s peso exposure on this shipment. Motion faces calls its bank and receives the following quotes on over-the-counter currency options:

30-day call option on Pesos with strike of $0.0470/peso $0.0008/peso

30-day put option on Pesos with strike of $0.0463/peso $0.0023/peso

How can Motion construct a currency collar to hedge its payable risk? What is the net premium paid for this collar? What is the net US dollar cost of the Peso 10 million using this currency collar if the future spot exchange rate in 30 days is Peso 21.2/$? If the future spot rate is Peso 21.8/$?

Expert Solution

To make a currency collar, Motion Inc can buy a call option and sell a put option.

Net premium paid per peso = $0.0008 - $0.0023 = -$0.0015/peso (there is a net premium received, since the premium received from selling the put option is higher than the premium paid to buy the call option)

Net dollar cost if spot exchange rate in 30 days is Peso 21.2/$

Spot exchange rate = 1 / 21.2 = $0.047170/peso

As the spot exchange rate is higher than the call option strike price, the call option will be exercised.

As the spot exchange rate is higher than the put option strike price, profit on put option = premium received.

Net dollar cost = (call option strike price - premium received on put option) * number of pesos

Net dollar cost = ($0.0470 - $0.0023) * 10,000,000

Net dollar cost = $447,000

Net dollar cost if spot exchange rate in 30 days is Peso 21.8/$

Spot exchange rate = 1 / 21.8 = $0.045872/peso

As the spot exchange rate is lower than the call option strike price, the call option will not be exercised. The pesos will be purchased at the spot exchange rate.

As the spot exchange rate is lower than the put option strike price, loss on put option = (put option strike price - spot exchange rate - premium received)

loss on put option = ($0.0463 - $0.045872 - $0.0023) = -$0.001872 (there is a profit on the put option)

Net dollar cost = (spot exchange rate + loss on put option) * number of pesos

Net dollar cost = ($0.045872 + (-$0.001872)) * 10,000,000

Net dollar cost = $440,000

jeff jeffy answered 2 years ago

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