Question
Assume that Great Lake Corp. from the United States will receive 40 million in 180 days from its export order. It has collected the following
Assume that Great Lake Corp. from the United States will receive 40 million in 180 days from its export order. It has collected the following information: 180day U.S. interest rate = 7% per annum [Note: you have to convert this to a 180-day rate] 180day British interest rate = 6% per annum 180day forward rate of British pound = $1.39 Spot rate of British pound = $1.29 The 180-day call option on 10 million with a strike price of $1.30/ has a premium of $0.011 per pound. The 180-day put option on 10 million with a strike price of $1.41/ has a premium of $0.021 per pound. Great Lake is concerned with the volatile exchange rate between the dollar and the euro and would like to hedge exchange rate exposure.
a) Compute the guaranteed dollar proceeds from the sale if Great Lake decides to hedge using a forward contract.
b) If Great Lake decides to hedge using money market instruments (MMH), what action does Great Lake need to take? (List all the steps needed). What would be the guaranteed dollar proceeds from the sale in this case?
c) If Great Lake decides to hedge using options on pounds, what option (call or put) it needs to use? What would be the expected dollar proceeds? Assume that Great Lake regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.
d) Recommend a hedge method for Great Lake and explain using the numbers you got from the previous questions (a) to (c).
e) Other things being equal, at what forward rate would Great Lake be indifferent between the forward and money market hedge?
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