Plantronics, a US company, owes SKr 50 million, due in one year, for some electr
ID: 2780504 • Letter: P
Question
Plantronics, a US company, owes SKr 50 million, due in one year, for some electrical equipment it recently bought from ABB Asea Brown Boveri in Sweden. At the current spot rate of $0.1480/SKr, this payable is $7.4 million. It wishes to hedge this payable but is undecided how to do it. The one-year forward rate is currently $0.1436. Plantronics' treasurer notes that the company has $10 million in a marketable U.S. dollar CD yielding 7% per annum. At the same time, SE Banken in Stockholm is offering a one-year time deposit rate of 10.5%.
Required
What are the costs of each hedging alternative (forward vs. money market ) for Plantronics? Which is preferred?
(ii) Determine the break even exchange rate between the two hedging strategies,
Cosmo, a Japanese exporter, wishes to hedge its $15 million in dollar receivables coming due in 60 days. In order to reduce its net cost of hedging to zero, however, Cosmo sells a 60-day dollar call option for $15 million with a strike price of ¥98/$ and uses the premium of $314,000 to buy a 60-day $15 million put option at a strike price of ¥90/$.
Required
Show graphically Cosmo’s currency collar hedge position over the range ¥80/$-¥110/$. What risk is Cosmo subjecting itself to with this option hedge?
What is the net yen value of Cosmo's option hedged position at the following future spot rates: ¥85/$, ¥95/$, and ¥105/$?
Explanation / Answer
The answer to the first question which is of Plantronics case study would be as follows:
1. (a) Plantronics can use the forward market to lock in a cost for its payment of $7.18 million. Alternatively, Plantronics can use a money market hedge to lock in a lower dollar cost of $7,165,611 for its payable. Thus, the money market hedge is the low-cost hedge.
(b) To compute this cost, note that Plantronics must invest SKr 45,248,869 today at 10.5% to have SKr 50 million in one year (45,248,869 × 0.105 = 50 million). This amount is equivalent to $6,696,833 at the current spot of SKr $0.1480/SKr. The opportunity cost to Plantronics of taking this amount from its CD today and converting it into SKr is $7,165,611, which is the future value of $6,696,833 invested at 7%.
The break-even strategy depends on the market value and we see that it will be beneficiary for those as the future value that we invested in above case would be of 7% that will be the beneficiary.
2. Now the second case answer would be
As can be seen from the payoff diagram on Cosmo's currency collar, Cosmo is limiting the upside potential of its receivable with the call option but also limiting its downside risk. The put and call premiums of $314,000 cancel offset each other and so don't affect the payoff on the currency collar. The diagram reflects the fact that Cosmo will not exercise its put option at an exchange rate above ¥90/$ and the buyer will not exercise its call option below ¥98/$.Neither option, therefore, will be exercised in the range of ¥90/$:¥98/$.