CORPORATE EXCHANGE RISK MANAGEMENT

Transaction exposure

1. Dow Chemical has sold SFr 25 million in chemicals to Ciba-Geigy. Payment is due in 180 days. Spot rate: $0.7957/SFr 180-day forward rate: $0.8095/SFr 180-day U.S. dollar interest rate (annualized): 5% 180-day Swiss franc interest rate (annualized): 2% 180-day call option at $0.80/SFr: 2% premium 180-day put option at $0.80/SFr: 1% premium a. What is the hedged value of Dows receivable using the forward market hedge? b. Explain how Dow can use the money market hedge? c. Explain the use of currency options to hedge its receivable?

2. Magnetronics, Inc., a U.S. company, owes its Taiwanese supplier NT$205 million in three months. The company wishes to hedge its NT$ payable. The current spot rate is US$0.03990/NT$, and the three-month forward rate is NT$1 = US$0.04051. Magnetronics can also borrow/lend U.S. dollars at an annualized interest rate of 12% and Taiwanese dollars at an annualized interest rate of 8%.

a. What is the U.S. dollar cost by forward hedge?

b. What is the U.S. dollar cost by money market hedge? Describe the procedure it would use to get this price.

c. If the firm wanted to use option hedge, should it buy a call or put on NT$?

3. In contrast to simple examples in the text, many firms do not hedge their transaction exposures fully. Explain three reasons why they may remain partly or fully unhedged.

4. Sun Microsystems, a US firm, has decided to hedge only when it believes the dollar will strengthen. Otherwise, it will go uncovered. Comment on this policy.