A Swiss firm based in Swiss franc (CHF) seeks your advice in managing the exchange rate exposure on its US dollar (USD) transactions. The Swiss firm has just signed a contract in which they are selling goods to a USA buyer. In the deal, they are to receive a payment of USD 2M in 1 year. The current market information is as follows:

Exchange Market Interest rates (APR)

S(CHF per USD)_t = 0.9413 1-year CHF interest rates 0.7500%

1-year USD interest rates 2.2500%

a. Calculate the market price for a 1-year forward contract between CHF and USD. (4 decimal places, rounded)

b. An estimate of the volatility of the CHF/USD exchange rate in one year is USD0.09/FC. Determine an estimate of the expected future value AND the exchange rate risk that the Swiss firm faces on this USD payment in 1 year. (Hint: expected value and risk should be in units of CHF)

c. Assuming the distribution of exchange rates (CHF per USD) is a normal distribution, determine the CHF value in 1 year that would correspond to the worst 5% outcome of this transaction given the information above.

d. Describe the position in a forward contract the Swiss firm would enter into as a hedge of this exposure arising from the USD2M it will be receiving in 1 year. Determine the total currency A cash flows of the Country A firm at settlement for this transaction and this forward hedge.

The market is offering 1-year options on USD with a strike price of CHF0.90 per USD.

The premiums on these options are: Put option on USD: CHF0.0239 per USD

Call option on USD: CHF0.0512 per USD

e. Describe the single option position the Swiss firm would enter into as a hedge of this exposure. Determine, in FV terms, the worst-case CHF total future cash flows for the Swiss firm at settlement from this transaction with this option hedge. Assume that the Swiss firm pays the option premium today. (Hint: FV of premium in 1 year is premium today x (1 + i^CHF))

f. Graph in (XR(CHF per USD), FV of CHF) space and label the future values of the following positions:

. the FV CHF cash flows from the underlying exposure itself

. the FV CHF cash flows to the forward contract taken in part (b)

. the FV cash flows to the option contract described in part (c)

. the combined FV CHF cash flows to the underlying exposure and the forward contract as a hedge

. the combined FV CHF net cash flows to the underlying exposure and the option contract as a hedge