Question

Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million pay- able in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and the six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six- month interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States. a. Should a firm hedge? Why or why not? b. Compute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using a forward contract. c. If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case? d. If Airbus decides to hedge using put options on U.S. dollars, what would be the “expected” euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate. e. At what future spot exchange do you think Airbus will be indifferent between the option and money market hedge?

Answer 1

a)	Yes, the firm should hedge. The reason is that, hedging will help in
	determining the future outflow or inflow in domestic currency
	on the day the transaction in foreign currency is enered into. One
	can be prepared for the impact.
b)	Guaranteed euro proceeds from forward hedge = 30000000/1.10 =	€    2,72,72,727
c)	As Airbus has a $ receivable (asset), it has to create
	a $ liability that will have a maturity value equal to
	$3 million by 6 months.
	This will be achieved by borrowing in dollars.
	The amount to be borrowed = 30000000/1.03 =	$    2,91,26,214
	This amount will be converted to Euros at the current
	spot rate and invested in euros to get, after 6 months
	an amount equal to (29126214/1.05)*1.025 =	€    2,84,32,733
	This amount of Euros28,432,733 will be the guaranteed
	receipt under the MMH.
d)	As the unbiased estimate is more than the strike price
	the option will not be exercised. The $3 million
	obtained will be converted at the unbiased rate of 1.1
	to get 30000000/1.1 =	€    2,72,72,727
	FV of option premium paid upfront = 30000000*0.02*1.025 =	€          6,15,000
	Net amount received	€    2,66,57,727
e)	Amount receivable under the MMH =	€    2,84,32,733
	Rate under the MMH = 30000000/28432733 =	€              1.0551
	FV of premium per dollar = 0.02*1.025 =	€              0.0205
	Equivalent option rate	€              1.0346
	If the future spot is more than the rate of 1.0346$/Euro,
	the option will not be exercised.
	Hence, the required rate for indifference is	€              1.0346