(2)(a) Suppose that Loras corporation needs 100,000 euros 180 days from now. It is trying to determine whether or not to hedge this position. It developed the following probability distribution for the euro: Possible value of the pound in 180 days: $1.40 1.45 1.48 1.50 1.53 1.55 5% 10 30 30 20 5 Probability: The 180-day forward rate for the pound is $1.52 The spot rate for the pound is $1.49. Given the available information determine the expected value of the real cost of hedging and comment on the desirability or otherwise of hedging the payables. (b) A Factor agrees to buy an exporter's receivables at a 4.5% per month discount. In addition, the Factor charges a 2.25 % fee for non-recourse financing. If the exporter decides to factor $5million in 90-day receivables, how much will the exporter receive? If the financing is with recourse, will the amount received by the exporter be different? Explain with quantitative evidence. 3. A writer is currently selling 100 identical European calls and wants to minimise poten- tial losses with self-financing dynamic hedging. In the Cox-Ross-Rubenstein notation, the underlying asset of these calls has S = $50, u = = 1.3 and d = 0.8. The calls will mature in two time steps and have strike price K: $50. Over each time step the return is a constant R = 1.01. (a) Calculate the premium of one call. = = O when the writer sells 100 calls. What (b) Explain the hedging process at time t investments must the writer have in the hedge portfolio and what are their values? (c) Explain how the hedge portfolio changes over the first time step and what the writer has to do at time t 1 to maintain the self-financing dynamic hedging. = (d) If the 100 calls are exercised at maturity, then the writer must be able to sell 100 shares to the holder. Show how the writer obtains these 100 shares, while also settling any debt in the hedge portfolio, without making a profit or a loss. The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance a new research and development laboratory. The bonds will pay interest semiannually. It is now November, and the current cost of debt to the high-risk biotech company is 11%. However, the firm's financial manager is concerned that interest rates will climb even higher in coming months. The following data are available: Future prices: Treasury Bonds - $100,000; Pts 32nds of 100% Delivery month Open High Low Settle Change Open interest December 94'28 95'13 94'22 95'05 +0'07 591,944 March 96'03 96'03 95'13 95'25 +0'08 120,353 June 95'03 95'17 95'03 95'17 +0'08 13,597 a. Use the given data to create a hedge against rising interest rates b. Assume that interest rates in general increase by 200 basis points. How well did your hedge perform? c. What is a perfect hedge? Are any real-world hedges perfect? Explain.