# Fin 535 answer

**Topics:**Option, Futures contract, United States dollar

**Pages:**4 (854 words)

**Published:**September 15, 2014

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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