1. Cromwell plc is a UK based company which frequently trades in high-tech goods with USA-based companies. Historically the company has not hedged its currency transactions, but because of recent exchange rate volatility, currency hedging is now being considered. The following imports and exports are due in six months' time, designated in the currencies shown: Company A Company B Company C Cromwell exports to 150,000 Nil $500,000 Cromwell imports from $1,000,000 $700,000 400,000 Assume that it is now 30 September and that futures and options contracts mature at the relevant month end. Exchange rates $/ : Spot 3 months forward 6 months forward $/ 1.9966 - 2.0020 1.9876 - 1.9930 1.9711 - 1.9755 Annual borrowing and investing interest rates Sterling Dollar 6.5% - 5.2% 5.0% - 3.0% Traded currency options: Contract size 31,250 (premiums in cents per pound) Exercise price $1.9600 $1.9800 $2.0000 Calls December March 4.80 5.99 3.58 4.75 2.31 3.60 Puts December March 1.65 2.99 2.41 4.40 3.45 6.71 Required: (a) Show how the six-month currency risk could be managed using the following: i. Forward contracts ii. Money market hedge iii. Currency options so as to guarantee no worse an exchange rate than the current spot rate and hedging to the nearest whole contract. Illustrate the outcome if the spot rate in six months is $1.9700/. [15 marks] 1. Cromwell plc is a UK based company which frequently trades in high-tech goods with USA-based companies. Historically the company has not hedged its currency transactions, but because of recent exchange rate volatility, currency hedging is now being considered. The following imports and exports are due in six months' time, designated in the currencies shown: Company A Company B Company C Cromwell exports to 150,000 Nil $500,000 Cromwell imports from $1,000,000 $700,000 400,000 Assume that it is now 30 September and that futures and options contracts mature at the relevant month end. Exchange rates $/ : Spot 3 months forward 6 months forward $/ 1.9966 - 2.0020 1.9876 - 1.9930 1.9711 - 1.9755 Annual borrowing and investing interest rates Sterling Dollar 6.5% - 5.2% 5.0% - 3.0% Traded currency options: Contract size 31,250 (premiums in cents per pound) Exercise price $1.9600 $1.9800 $2.0000 Calls December March 4.80 5.99 3.58 4.75 2.31 3.60 Puts December March 1.65 2.99 2.41 4.40 3.45 6.71 Required: (a) Show how the six-month currency risk could be managed using the following: i. Forward contracts ii. Money market hedge iii. Currency options so as to guarantee no worse an exchange rate than the current spot rate and hedging to the nearest whole contract. Illustrate the outcome if the spot rate in six months is $1.9700/. [15 marks]
