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.

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

Exercise

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

Probability
\$.61...