Strategic Financial Management

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STRATEGIC FINANCIAL MANAGEMENT

REVISION

1. Selling Currency Call Options. Mike Suerth sold a call option on Canadian dollars for $.01 per unit. The strike price was $.76, and the spot rate at the time the option was exercised was $.82. Assume Mike did not obtain Canadian dollars until the option was exercised. Also assume that there are 50,000 units in a Canadian dollar option. What was Mike’s net profit on the call option?

ANSWER:

Premium received per unit = $.01
Amount per unit received from selling C$ = $.76
Amount per unit paid when purchasing C$ = $.82
Net profit per unit = –$.05
Net Profit = 50,000 units × (–$.05) = –$2,500

2. Speculating with Currency Put Options. Alice Duever purchased a put option on British pounds for $.04 per unit. The strike price was $1.80 and the spot rate at the time the pound option was exercised was $1.59. Assume there are 31,250 units in a British pound option. What was Alice’s net profit on the option?

ANSWER:

Profit per unit on exercising the option = $.21
Premium paid per unit = $.04
Net profit per unit = $.17
Net profit for one option = 31,250 units × $.17 = $5,312.50

3. Hedging With Currency Options. When would a U.S. firm consider purchasing a call option on euros for hedging? When would a U.S. firm consider purchasing a put option on euros for hedging?

ANSWER:

A call option can hedge a firm’s future payables denominated in euros. It effectively locks in the maximum price to be paid for euros.
A put option on euros can hedge a U.S. firm’s future receivables denominated in euros. It effectively locks in the minimum price at which it can exchange euros received.

4. Forward versus Currency Option Contracts. What are the advantages and disadvantages to a U.S. corporation that uses currency options on euros rather than a forward contract on euros to hedge its exposure in euros? Explain why an MNC use forward contracts to hedge committed transactions and use currency options to hedge contracts that are anticipated but not committed. Why might forward contracts be advantageous for committed transactions, and currency options be advantageous for anticipated transactions?

ANSWER:

A currency option on euros allows more flexibility since it does not commit one to purchase or sell euros (as is the case with a euro futures or forward contract). Yet, it does allow the option holder to purchase or sell euros at a locked-in price.

The disadvantage of a euro option is that the option itself is not free. One must pay a premium for the call option, which is above and beyond the exercise price specified in the contract at which the euro could be purchased. An MNC may use forward contracts to hedge committed transactions because it would be cheaper to use a forward contract (a premium would be paid on an option contract that has an exercise price equal to the forward rate). The MNC may use currency options contracts to hedge anticipated transactions because it has more flexibility to let the contract go unexercised if the transaction does not occur.

5. Speculating with Currency Futures. Assume that one year ago, the spot rate of the British pound was $1.70. One year ago, the one-year futures contract of the British pound exhibited a discount of 6%. At that time, you sold futures contracts on pounds, representing a total of 1,000,000 pounds. From one year ago to today, the pound’s value depreciated against the dollar by 4 percent. Determine the total dollar amount of your profit or loss from your futures contract.

ANSWER:

Spot rate 1 year ago = $1.70
Forward rate 1 year ago = $1.70 x (1– .06) = $1.598
Dollars received for 1,000,000 pounds = 1,000,000 x $1.598 = $1,598,000. Spot rate of pound = 4% less than 1 year ago = $1.632
Dollars that are now required to buy the 1,000,000 pounds = $1,632,000.
Profit = $1,598,000 - $1,632,000 = -$34,000 [loss]

6. Sensitivity of NPV to Conditions. Burton...
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