Assume you are the CFO of AIFS. Your analyst reports the following information (Use the following information for the remainder of the assignment): Current exchange rate is $1.16/. Forward rate is $1.175/. Expected final sales volume is 35,000. Worst case scenario is volume of 15,000. Best case scenario is volume of 50,000. Cost per student is 2000. Option premium is 2% of USD strike price. Option strike price is $1.165/.

10. What is the most profitable strategy for expected final sales volume is 35,000 and for the worst-case scenario volume of 15,000 (no hedge, forward contract, or option contract) a) if the exchange rate remains at $1.16/?

b) if the exchange rate will be $1.25/?

c) if the exchange rate will be $1.11/? d) What is the overall best strategy? Why?

ADDITIONAL INFO/SOLUTION

6. As the CFO, you decided not to hedge. Assuming expected final sales volume is 35,000, what are your total costs

a) if the exchange rate remains at $1.16/? Lets call this the baseline scenario. Total costs= $ 81,200,000 (Baseline scenario)

b) if the exchange rate will be $1.25/? How does this compare to the baseline case?Total costs= $ 87,500,000

c) if the exchange rate will be $1.11/? How does this compare to the baseline case? Total costs= $ 77,700,000

7. As the CFO, you decided to hedge using forward contracts. Assuming expected final sales volume is 35,000 and forward rate is $1.175/. What are your total benefit/cost and the percentage benefit/cost from hedging (compared to no hedging)

a) if the exchange rate remains at $1.16/?

Total loss= $1,050,000

% loss from hedging= 1.29%

b) if the exchange rate will be $1.25/?

Total benefit= $5,250,000

% benefit from hedging= 6%

c) if the exchange rate will be $1.11/?

Total loss= $4,550,000

% loss = $4,550,000 /$ 77,700,000

% loss from hedging= 5.85%

8. As the CFO, you decided to hedge using option contracts. What type of option is suitable for this case (call option or put option)? Why?

Exchange rate=$ 1.16/Euro

= Euro 0.862/$

DECLINE BY 0.011

Forward Rate = $1.175/ Euro

= Euro 0.851/$

As there is a decline in the value of Euros, the best strategy is a put option to hedge the fall in the home currency value (In the perspective of a exporter).

9. As the CFO, you decided to hedge using option contracts. What are your total benefit/cost and the percentage benefit/cost from hedging (compared to no hedging)

a) if the exchange rate remains at $1.16/? -46.6

b) if the exchange rate will be $1.25/? 123.4

c) if the exchange rate will be $1.11/? 46.6