Assignment
Directions:
Solve the following problems according to the instructions in the module assignment.
1. Your firm negotiated a forward contract to purchase 500,000 British pounds in 90 days to purchase British supplies. The 90-day forward rate was $1.25 per British pound. On the day the pounds were delivered the British pound spot rate was $1.30.
What is the real cost of hedging that is payable for the U.S. firm?
2. Assume the following information:
• 90 day U.S. interest rate = 1.5%
• 90-day Philippine interest rate = 3%
• 90-day forward rate of Philippine peso = $0.020
• Spot rate of Philippine peso = $0.025
Assume your firm in the United States will need 300,000,000 Philippine pesos in 90 days. It wishes to hedge this payables position.
Would it be better off using a forward hedge or a money market hedge? Provide the mathematical analysis to justify your position.
3. You believe that IRP presently exists. The nominal annual interest rate in Mexico is 13%. The nominal annual interest rate in the U.S. is 4%. You expect that annual inflation will be about 4% in Mexico and 4.5% in the U.S. The spot rate of the Mexican peso is $.10. Put options on pesos are available with a one-year expiration date, an exercise price of $.1008, and a premium of $0.014 per unit.
You will receive 1 million pesos in one year.
a. Determine the amount of dollars that you will receive if you use a forward hedge.
b. Determine the expected amount of dollars that you will receive if you do not hedge and believe in purchasing power parity (PPP).
c. Determine the amount of dollars that you will expect to receive if you use a currency put option hedge. Account for the premium you would pay on the put option.
4. Assume that Calumet Co. will receive 10 million pesos in 15 months. It does not have a relationship with a bank at this time, and therefore cannot obtain a forward contract to hedge its receivables at this time. However, in three months, it will be able to obtain a one-year (12-month) forward contract to hedge its receivables. Today the three-month U.S. interest rate is 3% (not annualized), the 12-month U.S. interest rate is 8%, the three-month Mexican peso interest rate is 5% (not annualized), and the 12-month peso interest rate is 20%. Assume that interest rate parity exists. Assume the international Fisher effect exists. Assume that the existing interest rates are expected to remain constant over time. The spot rate of the Mexican peso today is $.10.
Based on this information, estimate the amount of dollars that Calumet Co. will receive in 15 months.
5. Kanab Co. and Zion Co. are U.S. companies that engage in much business within the U.S. and are about the same size. They both conduct some international business as well.
Kanab Co. has a subsidiary in Canada that will generate earnings of about C$20 million in each of the next 5 years. Kanab Co. also has a U.S. business that will also receive about C$1 million (after costs) in each of the next 5 years as a result of exporting products to Canada that are denominated in Canadian dollars.
Zion Company has a subsidiary in Mexico that will generate earnings of about 1 million pesos in each of the next 5 years. Zion Co. also has a business in the U.S. that will receive about 300 million pesos (after costs) in each of the next 5 years as a result of exporting products to Mexico that are denominated in Mexican pesos.
The salvage value of Kanab's Canadian subsidiary and Zion's Mexican subsidiary will be zero in 5 years. The spot rate of the Canadian dollar is $.60 while the spot rate of the Mexican peso is $.10. Assume the Canadian dollar could appreciate or depreciate against the U.S. dollar by about 8% in any given year, while the Mexican peso could appreciate or depreciate against the U.S. dollar by about 12% in any given year.
Which company is subject to a higher degree of translation exposure? Explain.