International Finance Question

Topics: Derivative, Option, Strike price Pages: 2 (508 words) Published: August 6, 2012
1. Dayton is a U.S based manufacturer of gas turbine equipment. This company has concluded negotiations for the sales of a turbine generator to Regency (U.K) for total payment of £3,000,000 which is due in 90 days Given the following exchange rates and interest rates, what transaction exposure hedging strategy is now in Dayton’s best interest? Spot rate$1.7620/£

Expected spot rate in 90 days$1.7850/£
90-day forward rate$1.7550/£
90-day dollar deposit rate6.0% p.a.
90-day dollar borrowing rate8.0% p.a.
90-day pound deposit rate8.0% p.a.
90-day pound borrowing rate14.0% p.a.
Dayton’s WACC12.0% p.a.
Dayton has also collected data on two specific options as well: Strike ratePremium
90-day put option on £$1.750/£1.5%
90-day put option on £$1.710/£1.0%

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Annex A: Dayton Hedging Table

Based on the exchange rates and interest rates, the transaction exposure hedging strategy Dayton’s might considers: Forward Hedge or 90-Day put option on £ of $1.750/£. Very importantly to obtain one of the hedging options, Dayton’s has to understand the risk management and comfortable level of company capital. Forward hedge ensures the Dayton’s receives $5,265,000 on the spot rate at Day 90. Buying the put option on the $1.750/£ to ensure minimum receipt of $5,169,124.20. Dayton’s will be benefited and enjoyed the upside of the spot rate at Day 90 if it is lower than $1.750/£. Taking into consideration of comparing Forward vs. Market Money, Forward hedge will be preferred as it is more comfortable and least transaction exposure as it gives an assurance for forward hedge to Dayton’s of receipt of $5,265,000 in 90 days then the money market hedge that Dayton company has to receive either $5,183,855.07 with the condition of deposits at 6.0% p.a. from the $ converts to the £ with the borrowed upfront or using the term of...
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