FIN 350 International Finance Homework

FIN 350 International Finance Homework

FIN 350, International Finance

In Class Problems –Currency Derivatives

1. Winston Toys, a U.S. based firm distributes toys in Europe and expects to receive 750,000 EUR in three months. Winston is considering a put option (XDE) to sell those receivables in three months. Put option with a strike price of $1.30 and expiration in three months is available for Euros at a premium of 2.04 USD. Winston will incur a financing cost at the rate of 4.5% per year for any premium that needs to be paid for the option.

Winston has prepared the following probability chart for values of the EUR in the next three months.

(a) Calculate the net cash flow in each scenario if Winston hedges using the put option.

Possible Value

Probability

Net Cash Flow

1.25

25%

1.30

25%

1.35

20%

1.40

15%

1.45

15%

(b) What is the mean and standard deviation of net cash flows without hedging, and what is it after hedging?

(You can use your financial calculator for this purpose)

(c) What can you conclude from your observation in part b?

2. Your U.S. based MNC will be paying 400,000 Swiss Francs in six months. Your economist has forecast the Swiss franc’s spot rate in six months as follows:

Probability

Future Spot Rate

20%

0.65

50%

0.60

30%

0.55

Your treasurer has identified three possible hedging alternatives

I. Six month forward contract at 0.60

II. Money market alternatives with borrowing and leaning rates in U.S. at 5% and 2% respectively; while in Switzerland at 6% and 4%

III. Six month Call options with a strike price of 0.60 are available for a premium of $0.03 per unit

IV. Six month Put options with a strike price of 0.60 are available at a premium of $0.02 per unit

If the current spot rate is $0.62, which hedging alternative is the best for your MNC? (Show all your steps for the money market hedge calculation). You can fill the following table with cash flows expected in each scenario.

Probability

Future Spot Rate

Cash flow with forward hedge

Cash flow with option hedge

Cash flow with money market hedge

20%

0.65

50%

0.60

30%

0.55

 

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