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An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of
An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of ie= 5%. The bond costs 1,000 today and will return 1,050 at the end of one year without risk. The current exchange rate is 1.00 - $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (5/6) = 1.80 per Si (S/E) - 1.40 per Following revaluation, the exchange rate is expected to remain steady for at least another year. The hedge fund manager notices the optionality in starting this project today. He asks you to comment and outline your valuation strategy, 1) Show the valuation of this project as a risk-free bond, with the face value of $1,470 plus an at- the-money call option on 1,400 Euro with a strike price of $1.50/Euro. 2) What is the decision based on the calculated NPV based on 1)? 3) If the option to delay this project for one more year is also available, what is better between using call option and delaying the project for 1 year? An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of ie= 5%. The bond costs 1,000 today and will return 1,050 at the end of one year without risk. The current exchange rate is 1.00 - $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (5/6) = 1.80 per Si (S/E) - 1.40 per Following revaluation, the exchange rate is expected to remain steady for at least another year. The hedge fund manager notices the optionality in starting this project today. He asks you to comment and outline your valuation strategy, 1) Show the valuation of this project as a risk-free bond, with the face value of $1,470 plus an at- the-money call option on 1,400 Euro with a strike price of $1.50/Euro. 2) What is the decision based on the calculated NPV based on 1)? 3) If the option to delay this project for one more year is also available, what is better between using call option and delaying the project for 1 year
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