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Consider a US firm sells a gas turbine generator to a British firm; in March 201x for British pound BP 1,000,000. Payment is due three months later in June 201x. The firm’s cost of capital is 12%. The following quotes are current in the market:

1. spot rate: $1.764 per British pound

2. 3-month forward rate: $1.754 per British pound

3. 3-month interest rate for borrowing in U.K.: 2.5% Per quarter

4. UK 3-month investment rate: 2.0% /quarter

5. US 3-month borrowing rate: 2.0% /quarter

6. US 3-month investment rate: 1.5% per quarter

7. June put option in the over the counter market for British pound 1,000,000; strike price $1.71 (out-of-the money): 1% premium

8. June put option on the Philadelphia Stock Exchange:

British pound BP 31,250 per contract at strike price of $1.75 cost

2.5 cents per pound premium, and brokerage cost $50 per contract

9. the firm’s foreign exchange advisory service forecasts that the spot

rate in three months will be $1.76 per pound.

Show all your calculations of cost of the following alternatives:

(i) Unhedged Position; (ii) Money Market Hedge; (iii)Forward market hedge; and (iv) Options Hedge;

(Show your work. This means that No work is No credits)

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Bunny Greenfelder
Bunny GreenfelderLv2
28 Sep 2019

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Related questions

Looking at the following options table:

British Pound Option Prices (U.S. CENTS per Pound, 62,500 pounds per contract)
US cents/£ Call Call Call Put Put Put
Spot Rate Strike Price May June July May June July
144.8 144 0.88 1.42 1.44 0.52 1.06 -----
144.8 145 0.42 1.02 ----- ----- ----- -----
144.8

146

 0.2 0.68 0.72 1.75 2.32 -----
QUESTION A: Give me one example of an option that is out of the money? Be specific as far as month and strike price. Explain your answer?
QUESTION B: Give me one example of an option that is in the money? Be specific as far as month and strike price. Explain your answer?
QUESTION C: Which, if any, option is at the money? Explain your answer.
QUESTION D: Looking at the July 144 CALL option, break down the option's premium into its Intrinsic Value and Time Premium components
Show your calculations.
QUESTION E: Looking at the June 146 PUT option, break down the options premium into its Intrinsic Value and Time Premium components
Show your calculations.
QUESTION F : If you purchase two (2) June 145.0 call options what will be the total amount of your premium that you need to pay?
QUESTION G: Referring to QUESTION F, when do you pay the option premium, on the settlement date or on the date that you purchase the options?
QUESTION H: Today you purchase three (3) June 144.0 Puts. On settlement date the spot rate = 142.5 cents per pound, what is your net profit/loss?
Show your calculations.
QUESTION H: Today you purchase two (2) June 144.0 Calls. On settlement date the spot rate = 143.5 cents per pound, what is your net profit/loss?

3. Biogen expects to receive royalty payments totaling £1.25 million next month. It is interested in protecting these receipts against a drop in the value of the pound. It can sell 30-day pound futures at a price of $1.6513 per pound or it can buy pound put options with a strike price of $1.6612 at a premium of 2.0 cents per pound. The spot price of the pound is currently $1.6560, and the pound is expected to trade in the range of $1.6250 to $1.7010. Biogen's treasurer believes that the most likely price of the pound in 30 days will be $1.6400. a. How many futures contracts will Biogen need to protect its receipts? How many options contracts? b. Diagram Biogen's profit and loss associated with the put option position and the futures position within its range of expected exchange rates (see Exhibit 8.6). Ignore transaction costs and margins. c. Calculate what Biogen would gain or lose on the option and futures positions within the range of expected future exchange rates and if the pound settled at its most likely value. d. What is Biogen's break-even future spot price on the option contract? On the futures contract? e. Calculate and diagram the corresponding profit and loss and break-even positions on the futures and options contracts for those who took the other side of these contracts.

Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. • The spot exchange rate is $1.40/euro • The six month forward rate is $1.38/euro • Plains States' cost of capital is 11% • The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) • The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) • The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) • The U.S. 6-month lending rate is 6% (or 3% for 6 months) • December put options for euro 625,000; strike price $1.42, premium price is 1.5% • Plains States' forecast for 6-month spot rates is $1.43/euro • The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro If Plains States locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange ______ " accounting transaction of ________

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