Question

In: Finance

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
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