ABC Corportion has 90-day receivables of Euro 500,000. The following info is ava
ID: 2720692 • Letter: A
Question
ABC Corportion has 90-day receivables of Euro 500,000. The following info is available:
Spot rate of the Euro: $1.20 per Euro
90-day forward rate: $1.15 per Euro
90-day interest rates are as follows:
90-day deposit rate US = 5% Euro = 5%
90-day borrowing rate US = 7% Euro = 7%
A call option on Euro that expires in 90 days has an exercise price of $1.20 and has a premium of $0.03. A put option on Euro that expires in 90 days has an ecercise price of $1.20 and has a premium of $0.02, The Euro spot rate in 90 days is forecasted to be:
Possible Rate $1.15 and Probability of 30%
Possible Rate $1.10 and Probability of 70%
ABC Corporation is considering 1) a forward hedge 2) a money market hedge 3) an option hedge and 4) remaining un-hedged
You have been hired as a consultant to decide on the best possible hedge. Which one of the alternatives would you recommend and why?
Explanation / Answer
Euro receibables in 90 days = 500,000 Option I Take forward contract USD in 90 days 575000 Option II Remaining Un-hedged Rate Probability Rate applicable 1.15 0.3 0.345 1.1 0.7 0.77 Applicable rate 1.115 USD in 90 days 557500 Option III: Money market hedge Borrow in Euro and invest in $ Interest payable 500000*7%*(90/360) 8750 Deposit in $ Interest receivable 6726.457399 Net loss 2023.542601 $ in 90 days 555243.75 Option IV: Option Hedge Buy a put option Premium payable in $ 10000 On maturity Sell Euro and receive $ 600000 Less: premium 10000 total receivable 590000 Option hege is recommended due to highest receivable amount