La Trappe, brewed at De Koningshoeven Brewery, is Dutch Trappist beer. La Trappe enjoys worldwide sales. Bier
Question:
- La Trappe, brewed at De Koningshoeven Brewery, is Dutch Trappist beer. La Trappe enjoys worldwide sales. Bier & Wein Import Co. of Brazil specialises in importing beers from Europe. Payment of €50 million is due for imported La Trappe in six months. Bier & Wein is concerned with the volatility in the Brazilian Real exchange rate vis-à-vis the euro and its adverse effect on accounts payables. Therefore, the firm decides to hedge its exposure to foreign exchange risk and examines the prospects of forward hedge and money market hedge for the payables. Relevant information is collected as follows:
- Currently prevailing spot exchange rate: BRL4.8617/EUR
- Six-month forward exchange rate: BRL5.4823/EUR
- Money market rate in Brazil: 2.50% per annum for the six months
- Money market rate in euroland: 1.25% per annum for the next six months
Required:
(a) Demonstrate an appropriate forward hedge procedure for the case and illustrate the gain and loss profile of the forward hedge.
(b) Demonstrate an appropriate money market hedge procedure for the case and illustrate the gain and loss profile of the money market hedge.
(c) What will be the gain or loss from the forward hedge and the money market hedge respectively, if the exchange rate in six months is BRL4.6500/EUR?
(d) What will be the gain or loss from the forward hedge and the money market hedge respectively, if the exchange rate in six months is BRL5.7500/ERU?
(e) Discuss which of the two hedging methods may be preferred under the circumstances, with theoretical justification and empirical results evident by this case.
Business Law Principles for Today's Commercial Environment
ISBN: 978-1305575158
5th edition
Authors: David P. Twomey, Marianne M. Jennings, Stephanie M Greene