Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air F
ID: 2802865 • Letter: B
Question
Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €50 million which is payable in one year. The current spot exchange rate is $1.1/€ and the one year forward rate is $1.2/€. The annual interest rate is 5.0% in the U.S. and 2.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and wants to hedge its exposure.
1. If Boeing is considering two hedging alternatives: forward market hedging versus money monket hedging. Which alternative would you recommend?
a. Forward market hedging
b. money market hedging,
c. indifferent between the two alternatives
d. insufficient information to make a recommendation
2. Now Being also consider the hedging by using the one-year put option on € with the exercise rate of $1.05/€ for the premium of $0.08. Assume that your expected future spot exchange rate is the same as the forward rate. What is your ranking order of the three alternative and which one is the most preferred to the least perferred?
a. forward market, money market, option market
b. option market, forward market, money market
c. forward market, option market, money market
d. money market, option market, forward market
Explanation / Answer
1.Position of Boeing: Euro 50 receiveable.
Alternative 1. Forward Cover: Sell Euro 50 million Forward @1.20 , So inflow after 1 year= $60
Alternative 2: Money market cover:
Borrow the PV of Euro 50 million i.e., 50/1.02= Euro 49.0196,
Sell Euro Spot getting 49.0196*1.1= $53.92157
Invest $ @ 5% getting 53.92157*1.05=$56.61765
Inflow is higher under alternative 1, Hence Forward Market hedging is preferrable.
2.
Alternative 1. Forward Cover: Sell Euro 50 million Forward @1.20 , So inflow after 1 year= $60
Alternative 2: Money market cover:
Borrow the PV of Euro 50 million i.e., 50/1.02= Euro 49.0196,
Sell Euro Spot getting 49.0196*1.1= $53.92157
Invest $ @ 5% getting 53.92157*1.05=$56.61765
Alternate 3: Option cover :
buy Euro put @E= $1.05/Euro , premium= $0.08/Euro*50= $4
Receiveable= 50*1.05-4= $48.50
Best alternative is forward cover. least one is option cover, Hence Option 1 is correct