1. ABC is a US company that has a manufacturing subsidiary in Brazil. There have been large changes in the USD/BRL exchange rate over the last 5 years and the company has forecasted the following possible exchange rates and subsidiary values over the next year:
Probability USD/BRL Value (BRL) Value ($)
State 1 .20 $1 = 2.93 BRL 60,000,000 20,477,816
State 2 .20 $1 = 3.24 BRL 55,000,000 16,975,309
State 3 .20 $1 = 3.35 BRL 52,000,000 15,522,388
State 4 .20 $1 = 3.46 BRL 49,000,000 14,161,849
State 5 .20 $1 = 3.76 BRL 44,000,000 11,702,128
(a) Find the exchange exposure coefficient faced by ABC for its Brazilian subsidiary (i.e., find the b estimate from a regression)
(b) Describe in detail a hedge you could put in place to reduce this exchange exposure over the next 12 months using forward contracts on Barchart.com
(c) Show the effect of the hedge on the value of the subsidiary in $ if each state of the world occurs
2. Look up the most recent annual report (10-K) for a MNC (multi-national corporation) and review the company's policies on foreign currency hedging. Answer the following questions:
(a) Describe the company's hedging policies in general (i.e., what is the goal of the hedging; what transactions/assets are they hedging?)
(b) Describe the specifics of at least two different types of large transactions:
(i) What hedging instruments are used?
(ii) Is part of the risk left unhedged?
3. You are interested in purchasing Credit Default Swaps on a 100,000,000 Euro position in 5 year bonds issued by the government in Greece. Using the rates quoted at the CNBC bond page, answer the following:
- If you purchase Credit Default Swaps on 100,000,000 Euros in 5 year Greek government debt, describe the payments required under the credit default swap contract (assuming the payments are quarterly in arrears).
- If there is a default event after 3 years and debt is worth 40% of its face value, how much will the credit default swap pay (assume it is cash settled)? Show your calculation
- If you own 100,000,000 in 5 year bonds issued by the Greek government, are you perfectly hedged by the Credit Default Swap contract? Explain.