Intro

Great Lakes Water exports bottled water to Europe. The company expects to receive 2,000,000 euros () in one year from its exports.

The firm expects the following exchange rate scenarios and probabilities:

ScenarioSpot rate in one yearProbabilityA$1.120.4B$1.20.2C$1.280.4

The spot rate is $1.2 per euro and the one-year forward rate is $1.201 per euro. The U.S. interest rate is 3% and the euro interest rate is 12%.

A put option on euros expiring in one year costs $0.007 per euro and has an strike priceof $1.2 per euro.

Attempt 1/10 for 10 pts.

Part1

What is the expected dollar cash flow in one year if the company does not hedge its receivables (in $)?

Correct

ScenarioSpotrate in 1 yearProbabilityDollar cash flowA$1.120.4$2,240,000B$1.20.2$2,400,000C$1.280.4$2,560,000

Expected cash flow = 0.4 * $2,240,000 + 0.2 * $2,400,000 + 0.4 * $2,560,000

= $2,400,000

Attempt 1/10 for 10 pts.

Part2

What will be the cash inflow if the firm uses a forward contract (in $)?

Correct

Cash inflow in $ = Receivables x Forward rate

= 2,000,000 * $1.201/

= $2,402,000

Attempt 1/10 for 10 pts.

Part3

What is the value of the receivables in one year with a money market hedge (in $)?

Correct

With a money market hedge, the firm borrows euros, converts them to dollars and then invests the dollars in short-term securities (money market instruments). It uses its euroreceivables to pay off the loan.

Euros to be received in one year (future value):

FV=2,000,000=2,000,000

Euros borrowed now (present value):

PV=FV1+r=2,000,0001+0.12=1,785,714=1+=2,000,0001+0.12=1,785,714

Dollars received from converting eurosnow:

PV$=PVS$=

= 1,785,714$1.2/1,785,714$1.2/

= $2,142,857$2,142,857

Value of dollar investment after one year (future value):

FV$=PV$(1+r$)$=$(1+$)

= $2,142,857(1+0.03)$2,142,857(1+0.03)

= $2,207,143

Attempt 3/10 for 8 pts.

Part4

What is the expected value of the receivables in one year with the put option hedge (in $)? Ignore the time value of money, i.e., the fact that the option premium has to be paid now rather than in a year.

Submit

Attempt 4/5 for 4 pts.

Part5

What is the optimal strategy for the company?

Money market hedge

Forward contract

No hedging

Put options

Correct

Since the put option hedge results in the largest dollar cash flow, it is the optimal strategy for the firm.

Attempt 7/10 for 8 pts.

Part6

If the exchange rate turns out to be $1.36 per euro in one year, what was the cost of hedging if the company followed the optimal strategy identified in the previous part (in $)?

Please solve 4 and 6. Those are the only ones I need. Please be correct. I have gotten many wrong answers recently whenever I have asked chegg. I will like for sure if they r correct