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?
Step by Step Answer:
Foundations Of Multinational Financial Management
ISBN: 9780470128954
6th Edition
Authors: Alan C Shapiro, Atulya Sarin