Coleman needs 100,000 euros in 1 year, then it could convert dollars to euros an
ID: 2654873 • Letter: C
Question
Coleman needs 100,000 euros in 1 year, then it could convert dollars to euros and deposit the euros in a bank today.The Coleman purchasing team received this price quote of €100,000 today where the current spot rate was $1.1800/€, which equates to the U.S. dollar price of $118,000.
Coleman's director of finance now wondered if the firm should hedge against more fluctuation in the exchange rate.
Three approaches were possible:
1) Hedge in the forward market. The 1-year forward exchange quote was $1.20/€.
2) Hedge in the money market. Coleman could borrow U.S. dollars from its U.S. bank at 7.00% per annum. The EU investment rate is 9.00% per annum.
3) Hedge with foreign currency options. The day the Euros are needed the call options at $1.2000/€ could be purchased for a premium of $0.03. (Note: First you need to figure out the option premium in percentage. The spreadsheet cell D32 is not set-up for USD)
Discuss if Coleman should hedge its transaction exposure of EUR 100,000. If you recommend that the company should hedge, which of the hedging alternatives would better serve Northwind shareholders?
Option premium ?
Solve this using step by step calculations
Assumptions Value 1-year A/P in € ? Spot rate, ($/€) ? 1-year forward rate, ($/€) ? EU investment rate ? borrowing rate, USD, per annum ? Coleman's WACC 10.000% Time to maturity (in months) 12.00 Options on Euro: 1-year Strike price, ($/€) Call Option Strike price ($/£) ?Option premium ?
Solve this using step by step calculations
Explanation / Answer
The buyer needs 100000 euros, then
Colemann need euro 100000 Current spot rate = 1 Euro =$1.1800 Equivalent US dollar price = $1.1800*100000 = $118000 1. IF he enters into forward market then dollars required 1year forward rate 1Euro = $1.20 Equivalent dollars required = 1.2*100000 =120000 2. Under money market operation Colemn requires to pay euro 10000 so he should invest the amount in the Euro then the amount shall be deposited = Final payment / ( 1 + annual interest rate) = 10000/ (1+ 0.09) = euro 91743.12 Now convert the amount into $ at spot rate 1Euro = $1.1800 = 91743.12*1.18 = 108256.88 Borrw such amount from bank for one year and final amount shall be payable to bank would be= = amount borrowed *( 1 + annual interest rate) = 108256.88(1+0.07) = 115834.86