Question

Suppose I own a soccer ball producing firm in London England and I am selling 10,000 soccer balls in 90 days to the US for a price of $160,000. The current spot rate is $ 1.5 / £. We are going to use the option market to hedge against unfavorable exchange rate movements.

You must show all work for full credit.

a) Considering this transaction only, what do we mean by 'unfavorable' exchange rate movements?

b) Suppose it costs me £ 95,000 to produce and transport the soccer balls, if the exchange rate in 90 days is the same as the current spot ($1.5/£), what is my profit in terms of British pounds (£)?

Suppose that there are options available that give me the option to exchange $ for £ at an exchange rate of $1.5 per £ 90 days from now. Suppose these options collectively cost you £ 5000. We are going to consider two separate scenarios:

Scenario #1: In 90 days, the spot exchange rate is $ 1.6/£.

Scenario #2: In 90 days, the spot exchange rate is $ 1.4/£.

Reminder: The options give you the right, not the obligation to exchange your $160,000 at $1.5 per £.

c) Given Scenario #1, what is your total profit / loss from selling the soccer balls?

d) Given Scenario #2, what is your profit / loss from selling the soccer balls?

Answer 1

a. "Unfavorable" exchange rate movement is we know that 1Euro =1.12 Dollar  

in case we cut invoice in dollar but we receive in euro if any increase in the exchange rate Euro per dollar reverse effect .

if any change in Euro per Dollar would to lesser receivables so it condition Unfavorable.if exchange rate is fixed than we deal with it.

b. Given value, Amount in Dollars =$160,000

Current spot rate =$ 1.5 / £

Amount receivable in Euro =106,666.667

We knoe that Amount receivable =Amount in Dollar/Current spot rate

Cost =95000

Profit= 11666.667

2.  

S.no	Particular	Amount
	Amount in US Dollar	160000
	Contracted Rate	1.5
	Receivable as contacted rate	106,666.666
1	Premium	-5000
	Receivable as per spot rate	100,000
	Net Receivable	95,000
	Receivable if spot rate rate 1.5	106,666.67
	Loss	11666
2	Premium	-5000
	Receivable as per spot rate	114,285.714
	Net Receivable	109,285.714
	Receivable if spot rate rate 1.5	106,666.67
	Gain	2619.004

So it clearly says that in first case if spot exchange rate 1.6 than we get a Loss.

and second case if spot exchange rate 1.4 than we got a Gain.