Comparison of Techniques for Hedging Receivables

a. Assume that Carbondale Co. expects to receive S$500,000 in 1 year. The existing spot rate of the Singapore dollar is $.60. The 1-year forward rate of the Singapore dollar is $.62. Carbondale created a probability distribution for the future spot rate in 1 year as follows:

FUTURE SPOT RATE PROBABILITY

$.61 20%

.63 50

.67 30 Assume that 1-year put options on Singapore dollars are available, with an exercise price of $.63 and a premium of $.04 per unit. One-year call options on Singapore dollars are available with an exercise price of

$.60 and a premium of $.03 per unit. Assume the following money market rates:

U.S SINGAPORE Deposit rate 8% 5%

Borrowing rate 9 6 Given this information, determine whether a forward hedge, a money market hedge, or a currency options hedge would be most appropriate. Then compare the most appropriate hedge to an unhedged strategy, and decide whether Carbondale should hedge its receivables position.

b. Assume that Baton Rouge, Inc., expects to need S$1 million in 1 year. Using any relevant information in part

(a) of this question, determine whether a forward hedge, a money market hedge, or a currency options hedge would be most appropriate. Then, compare the most appropriate hedge to an unhedged strategy, and decide whether Baton Rouge should hedge its payables position.