Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €30 million which is payable in one year. The current spot exchange rate is $1.05/€ and the annual inter- bank interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and wants to hedge its exposure through a forward hedge.
a) What kind of forward contract should they enter, and what is the fair price of that forward contract?
b) Suppose the actual one-year forward rate is $1.06/€. Describe the forward hedge including all related cash-flows.
c) A month passes, the spot rate is now $1.08/€. What is the value of the forward position Boeing entered in b)?
One of Boeing’s consultants suggests thinking about a money market hedge instead. Boeing can borrow at 50bps above the inter-bank interest rate in the U.S. and also in France, while the interest on deposits that they get is 50bps below the inter-bank rates.
d) Describe the money market hedge including all related cash-flows. Should Boeing prefer the money market hedge to the forward hedge?
e) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods?