Question
Exchange rate exposure: Suppose an Irish company has a 500,000 receivable due in 3 months and the company is very worried about the weakening in
Exchange rate exposure: Suppose an Irish company has a 500,000 receivable due in 3 months and the company is very worried about the weakening in light of uncertainty around Brexit. You have the following information: Spot Rate: 0.89 per Euro 90-day forward rate: 0.95 per Euro 90-day interest rate in UK is 4% per annum 90-day interest rate in Eurozone is 2.5% per annum Call option on the with a strike rate of 1.1236 per and a premium of Euro 0.04 per .
a. Using the data above, how can the Irish company hedge its exposure? What are the cash flows associated with each method? (Assume that the call options expire on the same day the receivable is due) Highlight the benefits and costs of each approach.
b. What are futures contracts on currencies? Discuss the similarities and differences between forward and futures contracts. What are the benefits and risk of each (forward contracts and futures contracts) when they are used as hedges against currency risk?
c. What type of exposure does the company in this example face? What are the different types of exchange rate exposure? Discuss whether and how companies can manage the different types of exposure.
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