Suppose a Ghanaian company, NFC Ltd, exported goods to MNP Ltd, British company and billed £10...

Suppose a Ghanaian company, NFC Ltd, exported goods to MNP Ltd, British company and billed £10 million payable in one year.

The money market interest rates and foreign exchange rates are given as follows:
Foreign exchange rates   Money market interest rates
Spot rate GHS5.50/£   Ghana 6.10% per annum
Forward rate GHS5.70/£ (I year maturity)   UK 9.00% per annum

a.   Calculate the GHS proceeds from this transaction if NFC Ltd hedged its receivable through a forward market contract.
b.   Suppose on maturity date, the spot rate turns out to be GHS6.50/£. Will NFC Ltd be worst off under the forward hedge? Calculate the gain/loss.
c.   If NFC Ltd decides to hedge using put options, what would be the ‘expected’ GHS proceeds from this transaction?
d.   Suppose the spot rate at maturity is GHS6.50/£. Will NFC Ltd be better or worse off under the option hedge? Assume the option premium is GHS0.01 per pound and the exercise price is GHS5.70/£ (1 year maturity)

Solutions

Expert Solution

a. Calculate the GHS proceeds from this transaction if NFC Ltd hedged its receivable through a forward market contract.

GHS Proceed under forward hedge = Forward rate, F x Quantity of Pounds, Q = GHS 5.70/£ x £10 million = GHS 57 million

b. Suppose on maturity date, the spot rate turns out to be GHS 6.50/£. Will NFC Ltd be worst off under the forward hedge? Calculate the gain/loss.

Spot rate > Forward rate. Hence NFC Ltd is worse off and the Loss = (Spot - Forward) x Q = (6.50 - 5.70) x 10 mn = GHS 8 mn

c. If NFC Ltd decides to hedge using put options, what would be the ‘expected’ GHS proceeds from this transaction?

Proceeds = Strike Price, K x Q - option premium, P x Q = 5.70 x 10 mn - 0.01 x 10 mn = GHS 56.90 mn

d. Suppose the spot rate at maturity is GHS6.50/£. Will NFC Ltd be better or worse off under the option hedge? Assume the option premium is GHS0.01 per pound and the exercise price is GHS5.70/£ (1 year maturity)

Payoff on the put option = max (K - S, 0) = max [(5.70 - 6.50) x 10 mn, 0] = 0; NFC will not exercise the option.

Premium paid = - 0.01 x 10 mn = - GHS 0.10 mn

Proceeds from sell in open market = S x Q = 6.50 x 10 mn = GHS 65 mn

Net proceeds = 65 mn - 0.10 = GHS 64.90 mn

Net proceeds in excess of proceed under forward contract = 64.90 - 5.70 x 10 = GHS 7.90 mn

Hence, NFC is better off under the option hedge. Put option has given a downside protection to NFC.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £20 million payable in...

Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £20 million payable in one year (i.e., Boeing has a £20 million receivable in one-year). The money market rates, foreign exchange rates, and option prices are given as follows: The U.S. one-year interest rate: 2% per annum The U.K. one-year interest rate: 3.5% per annum The spot exchange rate: $1.32/£ One-year forward rate: $1.2985/£ Call option: exercise rate: $1.31, premium: $0.015/£ Put option: exercise rate: $1.31, premium: $0.02/£...

Suppose Boeing Corporation exported a Boeing 787 to British Airway (BA) and billed BA £15 million...

Suppose Boeing Corporation exported a Boeing 787 to British Airway (BA) and billed BA £15 million payable in one year. The money market rates and foreign exchange rates are given as follows: The U.S. one-year interest rate: 3.25% per annum The U.K. one-year interest rate: 1.75% per annum The spot exchange rate: $1.35/£ Show the money market hedge strategy that the company can use to hedge the company’s transaction exposure. Be sure to include the following. State which currency Boeing...

Suppose Boeing Corporation exported a Boeing 787 to British Airway (BA) and billed BA £15 million...

Week 10 Fujitsu Ltd purchases inventory from DFO Ltd, a listed British company. Relevant events and...

Week 10 Fujitsu Ltd purchases inventory from DFO Ltd, a listed British company. Relevant events and the spot rates at each date are shown as follows: Date Event Spot rate 15 March 2019 Order £300,000 of inventory A$1.00 = £0.37 11 May 2019 Purchase takes place as inventory shipped to Fujitsu Ltd (FOB) A$1.00 = £0.41 30 June 2019 End of financial year A$1.00 = £0.43 02 July 2019 Inventory arrives at warehouse A$1.00 = £0.42 14 August 2019 Payment...

Presented below are transactions related to Tamarisk, Inc. May 10 Purchased goods billed at $15,600 subject...

Presented below are transactions related to Tamarisk, Inc. May 10 Purchased goods billed at $15,600 subject to cash discount terms of 2/10, n/60. 11 Purchased goods billed at $14,400 subject to terms of 1/15, n/30. 19 Paid invoice of May 10. 24 Purchased goods billed at $14,400 subject to cash discount terms of 2/10, n/30. 1. Prepare general journal entries for the transactions above under the assumption that purchases are to be recorded at net amounts after cash discounts and...

Presented below are transactions related to Metlock, Inc. May 10 Purchased goods billed at $12,200 subject...

Presented below are transactions related to Metlock, Inc. May 10 Purchased goods billed at $12,200 subject to cash discount terms of 2/10, n/60. 11 Purchased goods billed at $17,100 subject to terms of 1/15, n/30. 19 Paid invoice of May 10. 24 Purchased goods billed at $13,600 subject to cash discount terms of 2/10, n/30. prepare general journal entries for the transactions above under the assumption that purchases are to be recorded at net amounts after cash discounts and that...

Suppose that the British economy produces two goods: laptops and books. The quantity produced and the...

Suppose that the British economy produces two goods: laptops and books. The quantity produced and the prices of these items for 2015 and 2016 are shown in the table below: Year Quantities produced Price ($) 2015 Laptops = 60 Books = 1,000 Laptops = 200 Books = ? 2016 Laptops = 80 Books = ? Laptops = 90 Books = 12 Instructions:Round your answer to two decimal places. a. Let’s assume that the base year was 2015, so that real...

Suppose that the British economy produces two goods: laptops and books. The quantity produced and the...

Suppose that the British economy produces two goods: laptops and books. The quantity produced and the prices of these items for 2015 and 2016 are shown in the table below: Year Quantities produced Price ($) 2015 Laptops = 50 Books = 1,000 Laptops = 250 Books = ? 2016 Laptops = 90 Books = ? Laptops = 150 Books = 10 Instructions: Round your answer to two decimal places. a. Let’s assume that the base year was 2015, so that...

MacLoren Automotive manufactures British sports cars, several of which are exported to New Zealand for payment...

MacLoren Automotive manufactures British sports cars, several of which are exported to New Zealand for payment in pounds sterling. The distributor sells the sports cars in New Zealand for New Zealand dollars. The New Zealand distributor is unable to carry all the foreign exchange risk and would not sell MacLoren models unless he could share some of the foreign exchange risk. MacLoren has agreed that sales for a given model year will initially be priced at a base spot rate...

In 2010, a country imported goods worth $500 billion and exported goods worth $443 billion. It...

In 2010, a country imported goods worth $500 billion and exported goods worth $443 billion. It exported services worth $248 billion and imported services worth $330 billion. Payments on investments abroad totaled $199 billion, while returns paid on foreign investments were $125 billion. Unilateral transfers from the country to other nations amounted to $94 billion. What was the country’s current account deficit for 2010? A. $70 billion B. $159 billion C. $142 billion D. $65 billion

Subjects