Bobcat Company. Bobcat Company, U.S.-based manufacturer of industrial equipment,
ID: 2760145 • Letter: B
Question
Bobcat Company. Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was Won 8,000 million. Won 1,000 million has already been paid, and the remaining Won 7,000 million is due in six months. The current spot rate is Won 1,115/$, and the 6-month forward rate is Won 1,175/$. The 6-month Korean won interest rate is 17% per annum, the 6-month U.S. dollar rate is 4.5% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A 6-month call option on won with a Won1.200/S strike rate has a 4.1% premium, while the 6-month put option at the same strike rate has a 3.4% premium. Bobcat can invest at the rates given above, or borrow at 2% per annum above those rates. Bobcat's weighted average cost of capital is 11.5%. Compare alternate ways below that Bobcat might deal with its foreign exchange exposure. How much in U.S. dollars will Bobcat pay in 6 months without a hedge if the expected spot rate in 6 months is assumed to be Won 1,115/$? Won 1,175/$? How much in U.S. dollars will Bobcat pay in 6 months with a forward market hedge? How much in U.S. dollars will Bobcat pay in 6 months with a money market hedge? How much in U.S. dollars will Bobcat pay in 6 months with an option hedge if the expected spot rate in 6 months is assumed to be less than Won 1, 200/$? To be Won 1,300/$?Explanation / Answer
Spot Rate : 1 $ = Won 1,115
6 Month Forward Rate : 1 $ = Won 1,175
(a). How much in U.S. dollars will Bobcat pay in 6 Months without hedge?
Expected Exchange Rate : 1 $ = Won 1,115
Amount to be paid after 6 months (in Korean Won) = Won 7,000 Million
Amount to be paid after 6 months (in U.S. Dollar) = Won 7,000 Million / Won 1,115 per $ = $ 6.2780 Million
Expected Exchange Rate : 1 $ = Won 1,175
Amount to be paid after 6 months (in Korean Won) = Won 7,000 Million
Amount to be paid after 6 months (in U.S. Dollar) = Won 7,000 Million / Won 1,175 per $ = $ 5.9574 Million
(b) How much in U.S. dollars will Bobcat pay in 6 Months with Forward hedge?
Bobcat enters into a forward contract for 6 months to pay Won 7,000 Million at a Forward Rate of:
1 $ = Won 1,175
Then Bobcat shall have to pay after 6 months = Won 7,000 Million / Won 1,175 per $
= $ 5.9574 Million
Thus, Bobcat shall have to pay $ 5.9574 Million in 6 months with a Forward Hedge
(c) How much in U.S. dollars will Bobcat pay in 6 Months with Money Market Hedge?
Bobcat has to pay Won 7,000 Million at the end of 6 Months.
Today he shall invest in Korea, such an amount so as to receive Won 7,000 Million after 6 months at an interest of 17% p.a..
i.e. Bobcat shall invest = Won 7,000 Million / (1 + 0.17 x 6 / 12) = Won 6,451.61 Million
This amount of Won 6,451.61 Million to be expressed in U.S. $ = Won 6,451.61 / Won 1,115 per $
= $ 5.7862 Million
i.e. Bobcat shall borrow from U.S. Bank an amount of $ 5.7862 Million for 6 months
After 6 months Bobcat shall repay to U.S. bank an amount = $ 5.7862 Million x (1 + 0.065 x 6 / 12)
= $ 5.9743 Million
Thus, Bobcat shall have to pay $ 5.9743 Million in 6 months with a Money Market Hedge
The amount to be paid by Bobcat in 6 Months with a Money Market Hedge is lowest i.e. $ 5.9743. Thus, Bobcat should choose Option 3 and pay using Money Market Hedge.
6 Month Interest Rate Korea U.S. Deposit 17% p.a. 4.50% p.a. Borrowing 19% p.a. 6.50% p.a.