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ADMS 4540 Lecture Notes - Lecture 1: Call Option, Spot Contract

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School
York University
Department
Administrative Studies
Course
ADMS 4540
Professor
William Lim

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Document Summary

A canadian company will pay u. s. million for imports from u. s. in 3 months decides to hedge using a long position in a forward contract at an exchange rate of can. 20/u. s. . An investor owns 1,000 microsoft shares currently worth per share. A two-month put with a strike price of costs . The investor decides to hedge by buying 10 put contracts (each contract for 100 shares costing ). The 1st example: note that the company might do better if it chooses not to hedge than if it chooses to hedge. in 3 months, the hedge is not good. On the other hand, if the exchange rate is can. 30/u. s in 3 months, the hedge is good. There is no guarantee that the outcome with hedging will be better than the outcome without hedging. The 2nd example: the investor is concerned about a possible share price in the next 2 months.

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Related Questions

Coleman needs 100,000 euros in 1 year, then it could convert dollars to euros and deposit the euros in a bank today.The Coleman purchasing team received this price quote of €100,000 today where the current spot rate was $1.1800/€, which equates to the U.S. dollar price of $118,000.
Coleman's director of finance now wondered if the firm should hedge against more fluctuation in the exchange rate.
Three approaches were possible:
1) Hedge in the forward market. The 1-year forward exchange quote was $1.20/€.
2) Hedge in the money market. Coleman could borrow U.S. dollars from its U.S. bank at 7.00% per annum. The EU investment rate is 9.00% per annum.
3) Hedge with foreign currency options. The day the Euros are needed the call options at $1.2000/€ could be purchased for a premium of $0.03. (Note: First you need to figure out the option premium in percentage. The spreadsheet cell D32 is not set-up for USD)
Discuss if Coleman should hedge its transaction exposure of EUR 100,000. If you recommend that the company should hedge, which of the hedging alternatives would better serve Northwind shareholders?

Assumptions Value
1-year A/P in € ?
Spot rate, ($/€) ?
1-year forward rate, ($/€) ?
EU investment rate ?
borrowing rate, USD, per annum ?
Coleman's WACC 10.000%
Time to maturity (in months) 12.00
Options on Euro: 1-year Strike price, ($/€) Call Option
Strike price ($/£) ?

Option premium ?

Solve this using step by step calculations

A U.S. firm will need £100,000 in 90 days to pay for British imports. The firm tries to hedge this transaction using a forward contract. We know the following information:

*Spot exchange rate: £1=$1.38.

*90-day forward exchange rate: £1 = $1.40 .

(a) Should this firm buy or sell a £ forward contract if it wants to eliminate the uncertainty of the dollar payment for this accounts payable (A/P)?

(b) If management's forecast of the spot rate 90 days later is:

Possible spot rate of £ in 90 days Probability

$1.30 25%

$1.36 25%

$1.40 30%

$1.45 20%

calculate the expected (or average) dollars paid in 90 days for the forward hedge you have chosen in part (a). Calculate the expected (or average) real costs of this hedging strategy relative to the no hedging scenario.

(c) Draw a net profit graph for this forward contract.

The Sports Exports Company receives British pounds each month as payment for the footballs that it exports. It anticipates that the pound will depreciate over time against the U.S. dollar. 1. How can the Sports Exports Company use currency futures contracts to hedge against exchange rate risk? Are there any limitations of using currency futures contracts that would prevent the Sports Exports Company from locking in a specific exchange rate at which it can sell all the pounds it expects to receive in each of the upcoming months? 2. How can the Sports Exports Company use currency options to hedge against exchange rate risk? 3. Are there any limitations of using currency options contracts that would prevent the Sports Exports Company from locking in a specific exchange rate at which it can sell all the pounds it expects to receive in each of the upcoming months? 4. Jim Logan, owner of the Sports Exports Company, is concerned that the pound may depreciate substantially over the next month, but he also believes that the pound could appreciate substantially if specific situations occur. Should Logan use currency futures or currency options to hedge the exchange rate risk? Is there any disadvantage of selecting this method for hedging?