Exercise 4 (20 Points) MeDonnell Douglas just signed a contract to sell a DC 10 aircraft to Air France. Air France will be billed FF50 million which is payable in one year. The current spot exchange rate is $0.20/FF and the one-year forward rate is $0.19/FF. The annual interest rate is 6.0% in the U.S. and 9.5% in France. McDonnell Douglas is concerned with the volatile exchange rate between the dollar and the franc and would like to hedge exchange exposure. (a) It is considering two hedging alternatives: sell the franc proceeds from the sale forward (i.e. forvard hedge) or borrow francs from the Credit Lyonnaise against the franc receivable (i.e. money market hedge). Which alternative would you recommend? Why? (15 Points) (b) Other things being equal, at what forward exchange rate would McDonnell Douglas be indifferent between the two hedging methods? Hint: Use the TRP formula (5 Points) Exercise 5 (10 Points) Suppose a European firm has an asset in the United States which local price is random Assume there are only three states of the world and each state is equally likely to occur. The future local FS FG Rye FB F9 F10 5 of co IR T IZ N U G H J | Exercise 4 (20 Points) MeDonnell Douglas just signed a contract to sell a DC 10 aircraft to Air France. Air France will be billed FF50 million which is payable in one year. The current spot exchange rate is $0.20/FF and the one-year forward rate is $0.19/FF. The annual interest rate is 6.0% in the U.S. and 9.5% in France. McDonnell Douglas is concerned with the volatile exchange rate between the dollar and the franc and would like to hedge exchange exposure. (a) It is considering two hedging alternatives: sell the franc proceeds from the sale forward (i.e. forvard hedge) or borrow francs from the Credit Lyonnaise against the franc receivable (i.e. money market hedge). Which alternative would you recommend? Why? (15 Points) (b) Other things being equal, at what forward exchange rate would McDonnell Douglas be indifferent between the two hedging methods? Hint: Use the TRP formula (5 Points) Exercise 5 (10 Points) Suppose a European firm has an asset in the United States which local price is random Assume there are only three states of the world and each state is equally likely to occur. The future local FS FG Rye FB F9 F10 5 of co IR T IZ N U G H J |