Micca Metals, Inc. is a specialty materials and metals company located in Detroi
ID: 2778457 • Letter: M
Question
Micca Metals, Inc. is a specialty materials and metals company located in Detroit, Michigan. Micca just purchased a shipment of phosphates from Moroocco for 6,000,000 dirhams, payable in six months.
Six month call options on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar are available from Bank Al-Maghrub at a premium of 2%. Six- month put option on 6,000,000 dirhams at an exercise price of 10,00 dirhams per dollar are available at a premium of 3%. Compare and contrast alternative ways that Micca might hedge is foreign transaction exposure. What is your reccomendation?
Below is the table associated with the question.
Shipment of phosphates from Morocco, Morocco, dirhams 6,000,000
Micca's cost of capital (WACC) 14%
Spot exchange rate, dirhams/$ 10.00
6-month forward rate, dirham/$ 10.40
Explanation / Answer
1. Call option hedge. (Need to buy dirhams = call on dirhams) Option principal 60,00,000.00 Current spot rate, dirhams/$ 10.00 Premium cost of option 2.000% Option premium (principal/spot rate x % pm) $ 12,000.00 If option exercised, dollar cost at strike price of 10.00 dirhams/$ $ 6,00,000.00 Plus premium carried forward six months (pm x 1.07, WACC) 12,840.000 Total net cost of call option hedge if exercised $ 6,12,840.00 2. Forward market hedge. Buy dirhams forward six months. Account payable (dirhams) 60,00,000 Six month forward rate, dirhams/$ 10.40 Cost of settlement in six months (US$) $ 5,76,923.08 The lowest cost certain alternative is the forward. If Micca were to expect the dirham to depreciate significantly over the next six months, it may choose the call option.