ABC has just signed a contract to sell equipment to a manufacturer in Germany with

$2,500,000.$ The sell was made in January with payment due six months later in July.

Because this is a sizable contract for the firm and because the contract is in Euros rather

than dollars, OTI is considering several hedging alternatives to reduce the exchange rate

risk arising from the sale. To help the firm make a hedging decision you have gathered

the following information, and please compare each altemative and discuss how OTI

should hedge the cash flows.

The spot exchange rate is EUR$/$USD $0\mathrm{.}8924-27$

To find $6-$month forward rate, you call Banks, and they have access to Euro zoon $6-$month

interest rate of $6\mathrm{.}5\%-8\mathrm{.}5\%$ pa$,$ and the US $6-$month interest rate of $5\mathrm{.}5\%-7\mathrm{.}5\%$ pa

OTI's cost of capital is $11\%($WACC$)$

The Euro zone $6-$month money market rates are $7\%-9\%$ pa$.$

The U$.$S$.6-$month money market rates are $6\%-8\%$ pa$.$

The premium $($option price$)$ for December put options with strike price $$\mathrm{.}90$ is $1\mathrm{.}5\%$

The budget rate, or the lowest acceptable sale price for this project, is $$2,175,000$ or $$\frac{0\mathrm{.}87}{E}$

The July future contract has a future price of $$\frac{0\mathrm{.}895}{}$ when the contract is signed, and the future

will expire in $6$ months. Each future contract for the EURO has $125,000$ underline, and the

initial margin is $$2,565.$ We ignore all cash settlements during the $6$ months and assume

everything happens when the future expires.

There is also the tunnel forward $($zero cost range option$)$ strategic, The Put Option at strike price

$$0\mathrm{.}87$ and the Call Option at a strike price of $$0\mathrm{.}92$ currently are traded at the same premium.

Hints: there are following hedge tools available in this question: Forward, Money Market Hedge

$($invest or rollover in WACC or saving rates$),$ Option, Futures, and Tunnel Forward. $($Each

alternative worth $12$ points and the discussion also worth $10$ points, a total of $70$ points$)$