7. Dinky Toys’ cross-border acquisition (intermediate). Dinky Toys, Inc. (DTI)

of Pennsylvania has just purchased a Thai company that manufactures plastic beams and sockets for children’s construction toys. The purchase price is 120,000,000 Thai baht (THB) with payment due in six months. The current spot exchange rate is THB 43 = $1, and the six-month forward rate is THB 45 =

$1. Annual short-term interest rates are 12 percent in Thai baht and 4 percent in U.S. dollars.

a. Is the Thai baht at a premium or a discount? Compute the semiannually implied interest rate. Does it point toward an appreciation or depreciation of the Thai currency? The baht fluctuated within a range of THB 37 to 46 =

$1 over the past 18 months.

b. Compare the cost of alternative ways in which DTI could deal with its transaction exposure. Assume that DTI can lend at the given interest rate and borrow at 1 percent per annum above the lending interest rate. Sketch graphically your answers. What is your recommendation?

c. Six-month call and put options with exercise price of THB 46.50 are available for 3 percent and 2.4 percent annual premiums, respectively. Explain how DTI could use an option strategy to manage its transaction exposure.