Madison Inc. imports olive oil from Chilean firms and the invoices are always denominated in drachma (Dr).

Question:

Madison Inc. imports olive oil from Chilean firms and the invoices are always denominated in drachma (Dr). It currently has a payable in the amount of Dr 250 million that it would like to hedge. Unfortunately, there are no drachma futures contracts available and Madison is having difficulty arranging a Dr forward contract. Its treasurer, who recently received her MBA, suggests using Italian lira to cross-hedge the drachma exposure. She recently ran the following regression of the change in the exchange rate for the drachma against the change in the lira exchange rate:

a. There is an active market in forward lira. To cross-hedge Madison’s drachma exposure, should the treasurer buy or sell lira forward?

b. What is the risk-minimizing amount of lira that the treasurer would have to buy or sell forward to hedge Madison's Dr exposure?

Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question
Question Posted: