Effect of Man

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Question 1: The problem
a.What is Pixonix home currency?
The Canadian Dollar
b.What is Pixonix exchange rate exposure? What are they concerned about? Canadian Dollar appreciates versus the US Dollar. They are concerned about the decline of the Canadian Dollar that is forecasted in the second half of the following year.

Question 2: Scenario Analysis/Calculations
(please state your assumptions to get full credit)

Assume the following 3 possible exchange rate scenarios:
i.USD/CAD = 0.90 (that is $ 1 = C$ 0.90)
ii.USD/CAD = 1 (that is $ 1 = C$ 1)
iii.USD/CAD = 1.10 (that is $ 1 = C$ 1.10)

a.For each of the three exchange rate scenarios, calculate the total net payment cost for Pixonix in Canadian dollars of remaining unhedged. C$ appreciating vs. US$
$7M(C$0.90/US$)=C$6.3M
$7M(C$1.00/US$)=C$7M
$7M(C$1.10/US$)=C$7.7M

b.For each of the three exchange rate scenarios, calculate the total net payment cost for Pixonix in Canadian dollars if it hedges by going long a forward contract for US$ 7.5 million. Fill out the table below.

(Note: the forward rates are direct quotes for the Canadian dollar. For simplification, assume that the forward contract and payment all expire three months from November 2, 2007)

Table 1: Forward vs. Unhedged Position

Expected Spot Rate
in 3 monthsUnhedged
payment C$Forward gain/loss C$Net Payment C$
C$ 0.90/$6.75M
C$ 1.00/$7.5M
C$ 1.10/$8.25M

c.For each of the three exchange rate scenarios, calculate the total net payment cost for Pixonix in Canadian dollars if it hedges by purchasing a US dollar call option for US$ 7.5
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