Though the real estate market has been depressed in some countries due to the aftermath of the
global financial crisis, the markets in a few countries or cities have kept their robust growth in
prices and expansions. A noteworthy case is the commercial and residential properties in
Copenhagen, Denmark.
To tap into the above market, you have already entered into a sizeable investment in a
commercial property. The currency of Denmark is Danish Kroner, or Krone, and we use DKK
for it hereon.
In brief, you have made arrangements for the purchase of a commercial property in Copenhagen
for DKK 134.00 million. The functional currency of your company is the US dollar. Through
the help and guidance of your real estate agent, lots of detailed arrangements, including signing
of the contract, computing the closing costs, funding the purchase, etc., have already been taken
care of. The only remaining item that is the subject of this inquiry is a lump sum payment of
DKK 4,500,000.00 upon the occupancy (delivery) of the property, which is scheduled for three
months from today.
Considering the variations in the currency market these days, you are very concerned that your
expected payment of DKK 4,500,000.00 may impose unnecessary foreign exchange risk for your
company. You are considering several hedging alternatives to reduce the exchange rate risk
arising from this purchase. The following information is made available to you today:
? The spot exchange rate is DKK 5.66/$
? The three month forward rate is DKK 5.92/$
? Forecast of the management for the end of the third month is DKK 5.60/$
? The company's cost of capital is 12 percent per year.
? The Danish 3-month borrowing or lending rate is 6 % per annum
? The U.S. 3-month borrowing or lending rate is 3.4 % per annum
? A call or put option for the strike price of DKK 5.85/$ carries a premium of 1.25 percent
for this period.
Based on the above information, first read further instructions below, then answer the ensuing
FIFTEEN problems (why so many? See above!).
1. If your company chooses to hedge this exposure in the forward market, find out the outcome
of this hedge in the US dollar.
2. If your company chooses to hedge this exposure in the forward market, the outcome of this
hedge in the US dollar is certain (=1, enter 1 in the template), risky (=2, enter 2 in the
template), certain and risky (=3, enter 3 in the template).