Blueberry plc, a multinational company in the UK, expects to pay $7 million to a supplier in the US in three months' time. The current spot exchange rate of one pound to the dollar is $1.55-60 and the three-month forward exchange rate of one pound to the dollar is $1.53- 58. The spot exchange rate of one pound to the dollar in three months' time is expected to be as follows: Possible Future Spot Rate $1.45 $1.55 $1.65 Probability 40% 50% 10% Assume that three-month call option on pounds with an exercise price of $1.55/ can be purchased at a premium of 0.015 per $ and a three-month put option on pounds with the same exercise price can be purchased at a premium of 0.01 per $. The annualised values of three-month interest rates are as follows: Deposit rate Borrowing rate U.S. 1.50% 2.00% UK 3.00% 3.50% a) Given the information above, describe the strategies that the company can use to hedge the currency risk on this transaction? [3] b) For each of the strategies that you described in (a) above, calculate the amount of pounds that the company will pay for the $7 million it owes in three months' time, if the strategy is used. Which of the strategies that you considered in (a) and (b) above should the company use? Explain why. [15] c) Should the company hedge its exposure to currency risk on this transaction or not? Support your answer with appropriate calculations. [7] Blueberry plc, a multinational company in the UK, expects to pay $7 million to a supplier in the US in three months' time. The current spot exchange rate of one pound to the dollar is $1.55-60 and the three-month forward exchange rate of one pound to the dollar is $1.53- 58. The spot exchange rate of one pound to the dollar in three months' time is expected to be as follows: Possible Future Spot Rate $1.45 $1.55 $1.65 Probability 40% 50% 10% Assume that three-month call option on pounds with an exercise price of $1.55/ can be purchased at a premium of 0.015 per $ and a three-month put option on pounds with the same exercise price can be purchased at a premium of 0.01 per $. The annualised values of three-month interest rates are as follows: Deposit rate Borrowing rate U.S. 1.50% 2.00% UK 3.00% 3.50% a) Given the information above, describe the strategies that the company can use to hedge the currency risk on this transaction? [3] b) For each of the strategies that you described in (a) above, calculate the amount of pounds that the company will pay for the $7 million it owes in three months' time, if the strategy is used. Which of the strategies that you considered in (a) and (b) above should the company use? Explain why. [15] c) Should the company hedge its exposure to currency risk on this transaction or not? Support your answer with appropriate calculations. [7]
