Fin 535 answer

Topics: Option, Futures contract, United States dollar Pages: 4 (854 words) Published: September 15, 2014
32.Comparison of Techniques for Hedging Receivables.

a.Assume that Carbondale Co. expects to receive S$500,000 in one year.  The existing spot rate of the Singapore dollar is $.60.  The one‑year forward rate of the Singapore dollar is $.62.  Carbondale created a probability distribution for the future spot rate in one year as follows:

Future Spot Rate Probability
$.6120%
.6350
.6730

Assume that one‑year put options on Singapore dollars are available, with an exercise price of $.63 and a premium of $.04 per unit. One‑year call options on Singapore dollars are available with an exercise price of $.60 and a premium of $.03 per unit.  Assume the following money market rates:

U.S. Singapore
Deposit rate8%5%
Borrowing rate 96

Given this information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate.  Then compare the most appropriate hedge to an unhedged strategy, and decide whether Carbondale should hedge its receivables position.

ANSWER:

Forward hedge
Sell S$500,000 × $.62 = $310,000

Money market hedge
1.  Borrow S$471,698 (S$500,000/1.06 = S$471,698)
2.  Convert S$471,698 to $283,019 (at $.60 per S$)
3.Invest the $283,019 at 8% to earn $305,660 by the end of the year

Put option hedge (Exercise price = $.63; premium = $.04)

Possible Spot Rate

Option Premium per Unit

Exercise
Amount Received per Unit (also accounting for premium)

Total Amount Received for S$500,000

Probability
$.61
$.04
Yes
$.59
$295,000
20%
$.63
$.04
Yes or No
$.59
$295,000
50%
$.67
$.04
No
$.63
$315,000
30%
The forward hedge is superior to the money market hedge and has a 70% chance of outperforming the put option hedge.  Therefore, the forward hedge is the optimal hedge.

Unhedged Strategy

Possible Spot Rate
Total Amount Received for S$500,000

Probability
$.61...
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