1.- Suppose you work in the foreign sales department of Dell Computers (American company). In an attempt to further promote the sale of their new computer model in Europe, the company has decided to make a large sale invoiced in euros to a wholesaler in Madrid, Spain. The sale will amount to 1,550,000 euros, and will be paid on December. The economics research department has convinced John Skeptic, the CFO, of not covering the foreign exchange risk with forward or future contracts, since they expect a favorable movement in the exchange rate in the upcoming months, which has not been reflected in the forward rates. a) What would be a favorable movement in the exchange rate for your company? b) Why is it important to stress that the favorable movement in the exchange rate has not been reflected in the forward rates? This notwithstanding, the CFO is worried that the exchange rate predictions may not come true, and she decides to put you in charge of buying the necessary option contracts to hedge the position. Refer to the following table of option rates. c) Which kind of options would you be interested in (puts or calls)? d) What does it mean that these options are European style? e) If the CFO wants to obtain a minimum of 108 cents of a dollar for each euro, which option would you recommend to buy? f) How many contracts would you need to buy? g) How much will you pay in premiums for hedging this foreign exchange risk? h) If the exchange rate in December is such that one dollar exactly equals one euro, what are the total gains/losses from using the option contract? + OPTIONS CHICAGO MERCANTILE EXCHANGE (European style) Calls Puts Volume Last Volume Euro 125,000 euros; $ cents per euro Last 107.86 0.01 2,556 2.74 1,345 3,716 4,468 109 Oct 108 Oct 107 Oct 109 Dec 108 Dec 107 Dec 1.59 2.63 0.01 1.89 2.88 1.55 0.01 2.88 1.63 0.71 3,361 1,237 556 2,456 3,339 This table says that the current exchange rate for the euro/dollar is 1.0786 dollars for one euro. The prices are quoted in cents of a USD per euro traded. In this sense, the 109 put option is priced at (premium) 2.74 / 100 * 125,000 1.- Suppose you work in the foreign sales department of Dell Computers (American company). In an attempt to further promote the sale of their new computer model in Europe, the company has decided to make a large sale invoiced in euros to a wholesaler in Madrid, Spain. The sale will amount to 1,550,000 euros, and will be paid on December. The economics research department has convinced John Skeptic, the CFO, of not covering the foreign exchange risk with forward or future contracts, since they expect a favorable movement in the exchange rate in the upcoming months, which has not been reflected in the forward rates. a) What would be a favorable movement in the exchange rate for your company? b) Why is it important to stress that the favorable movement in the exchange rate has not been reflected in the forward rates? This notwithstanding, the CFO is worried that the exchange rate predictions may not come true, and she decides to put you in charge of buying the necessary option contracts to hedge the position. Refer to the following table of option rates. c) Which kind of options would you be interested in (puts or calls)? d) What does it mean that these options are European style? e) If the CFO wants to obtain a minimum of 108 cents of a dollar for each euro, which option would you recommend to buy? f) How many contracts would you need to buy? g) How much will you pay in premiums for hedging this foreign exchange risk? h) If the exchange rate in December is such that one dollar exactly equals one euro, what are the total gains/losses from using the option contract? + OPTIONS CHICAGO MERCANTILE EXCHANGE (European style) Calls Puts Volume Last Volume Euro 125,000 euros; $ cents per euro Last 107.86 0.01 2,556 2.74 1,345 3,716 4,468 109 Oct 108 Oct 107 Oct 109 Dec 108 Dec 107 Dec 1.59 2.63 0.01 1.89 2.88 1.55 0.01 2.88 1.63 0.71 3,361 1,237 556 2,456 3,339 This table says that the current exchange rate for the euro/dollar is 1.0786 dollars for one euro. The prices are quoted in cents of a USD per euro traded. In this sense, the 109 put option is priced at (premium) 2.74 / 100 * 125,000
