Question

You are the manager of a U.S. company situated in Los Angeles and manages the import/export division of the company. The company distributes (resells) a variety of consumer products imported to the U.S.A from Europe and also exports goods manufactured in the U.S.A. to Canada.

The first transaction is for the import of good quality wines from France, since a retail liquor trading chain customer in the United States, for who you have been doing imports over the past five years has a very large order this time. The producer in France informed you that the current cost of the wine that you want to import is and €2,500,000. The producer in France will only ship goods in three months’ time due to seasonal differences but payment will have to be conducted six months from now.

The second transaction is for the export of 3d printers manufactured in the U.S.A. The country where it will be exported to is Canada. The payment of CAD 2,500,000 for the export to Canada will be received twelve months from now.

You consider different transaction hedges, namely forwards, options and money market hedges.

You are provided with the following quotes from your bank, which is an international bank with branches in all the countries:

Forward rates:

Currencies	Spot	3 month (90 days)	6 month (180 days)	9 month (270 days)	12 month (360 days)
$/€	1.14134	1.14743	1.15354	1.15969	1.16587
$/CAD	0.76465	0.76559	0.77475	0.76748	0.76843

Bank applies 360 day-count convention to all currencies (for this assignment apply 360 days in all calculations).

Annual borrowing and investment rates for your company:

Country	3 month rates		6 months rates		9 month rates		12 month rates
	Borrow	Invest	Borrow	Invest	Borrow	Invest	Borrow	Invest
United States	2.687%	2.554%	2.713%	2.580%	2.740%	2.607%	2.766%	2.633%
Europe	0.505%	0.480%	0.510%	0.485%	0.515%	0.490%	0.520%	0.495%
Canada	2.177%	2.069%	2.198%	2.090%	2.220%	2.112%	2.241%	2.133%

Bank applies 360 day-count convention to all currencies. Explanation – e.g. 3 month borrowing rate on $ = 2.687%. This is the annual borrowing rate for 3 months. If you only borrow for 3 months the interest rate is actually 2.687%/4 = 0.67175% (always round to 5 decimals when you do calculations). Furthermore, note that these are the rates at which your company borrows and invests. The rates are not borrowing and investment rates from a bank perspective.

Option prices:

Currencies	3 month options				6 month options
	Call option		Put option		Call option		Put option
	Strike	Premium in $	Strike	Premium in $	Strike	Premium in $	Strike	Premium in $
$/€	$1.14399	$0.00174	$1.15088	$0.00174	$1.15010	$0.00173	$1.15702	$0.00152
$/CAD	$0.76292	$0.00392	$0.76828	$0.00392	$0.77205	$0.00387	$0.77747	$0.00387

Bank applies 360 day-count convention to all currencies. (Students also have to apply 360 days in all calculations). Option premium calculations should include time value calculations based on US $ annual borrowing interest rates for applicable time periods e.g. 3 month $ option premium is subject to 2.687%/4 interest rate.)

1. Compare the forward quotes and money market hedges with each other to determine the best exchange rate hedges for Canada

Table 7: Canada exchange rate hedges compared:

	Forward rate	Money market hedge locked in exchange rate
$/CAD

Which hedging technique should be applied? ____________________________________

Answer 1

	payment under forward contract
particulars	rate	amount	amount in $
payment for import	1.15354	€               2,500,000.00	$                   2,883,850.00
payment for export	0.76843	CAD 25,00,000	$                   1,921,075.00
	payment under money market contract
payment for import
Partiulars	working	invest rate	working	total	exchange rate	amount
amount to be borrowed in u.sa	0.485%/2	0.24%	2500000/(1+.24%)	€   2,494,014.37	1.14134	$   2,846,518.36
	working	borrow rate	working
payment to be made in dollars	2.713%/2	1.36%	2846518.36(1+1.3565%)	$   2,885,131.38
		.
payment for export
Partiulars	borrow rate	working	total	exchange rate	amount
amount to be borrowed in CAD	2.24%	2500000/(1+2.24%)	CAD 2445226.92	0.76465	$ 1,869,742.76
	invest rate	working	amount
payment undermoney market for CAD	2.63%	1869742.76*(1+2.63%)	$                   1,918,973.09
	comparision with forward and money market rate for CAD
particulars	amount	Rate
payment under forward contract	$ 1,921,075.00	$                        0.76843
payment under money market	$ 1,918,973.09	$                        0.76759
decision	forward contract is more beneficial to co.