it is a question of liquidity and financial risk management

Vegan Systems Inc is a US domiciled company that will receive 25m on the 31st of December from an overseas customer (it is now the 28th of February). Vegan are concerned that during the intervening period the \ will weaken decreasing the receipt amount in $'s. The following information is given regarding possible hedging alternatives. S. (@ 28th February) 123.78 - \124.65/$4 Sn (@ 31st December) 123.19 - W124.02/$4 F10mths \0.27 0.11/$ premium Borrowing Rates: US 7.5%, Japan 6.7% (per annum) Deposit Rates: US 3.3%, Japan 2.4% December Futures Rates: Now 123.55/$ (Contract size \12.5m) 31st December V123.12/$4 December Call Option: 0.012c/ (Strike Price $123.25/$) December Put Option: 0.025c/ (Strike Price 123.25/$) Requirements (a) With the benefit of hindsight which hedge should Vegan Systems Inc have taken (show all workings required to come to your conclusion and include an explanation as to your final recommendation)? (30 marks) Your answer should consider the following alternatives open to Vegan- System Inc: Forward contract MMH Futures . Option I The future exchange rates are sometimes estimated using the Fischer- equation (below) 1 + Foreign inflation rate Sn = So x 1 + Domestic inflation rate (b) With the Japanese inflation rate being 4.3% pa and the US rate being 2.1% pa (and using the spot rates given above) what would be an estimated exchange rate spread for the 31st of October? (5 marks) 2 (c) Compare and contrast the relative strengths of futures contracts and options as hedging instruments (Max word count is 90 words) (9 marks) (d) Illustrate how banks can generate a profit by selling forward contracts (6 marks) Vegan Systems Inc is a US domiciled company that will receive 25m on the 31st of December from an overseas customer (it is now the 28th of February). Vegan are concerned that during the intervening period the \ will weaken decreasing the receipt amount in $'s. The following information is given regarding possible hedging alternatives. S. (@ 28th February) 123.78 - \124.65/$4 Sn (@ 31st December) 123.19 - W124.02/$4 F10mths \0.27 0.11/$ premium Borrowing Rates: US 7.5%, Japan 6.7% (per annum) Deposit Rates: US 3.3%, Japan 2.4% December Futures Rates: Now 123.55/$ (Contract size \12.5m) 31st December V123.12/$4 December Call Option: 0.012c/ (Strike Price $123.25/$) December Put Option: 0.025c/ (Strike Price 123.25/$) Requirements (a) With the benefit of hindsight which hedge should Vegan Systems Inc have taken (show all workings required to come to your conclusion and include an explanation as to your final recommendation)? (30 marks) Your answer should consider the following alternatives open to Vegan- System Inc: Forward contract MMH Futures . Option I The future exchange rates are sometimes estimated using the Fischer- equation (below) 1 + Foreign inflation rate Sn = So x 1 + Domestic inflation rate (b) With the Japanese inflation rate being 4.3% pa and the US rate being 2.1% pa (and using the spot rates given above) what would be an estimated exchange rate spread for the 31st of October? (5 marks) 2 (c) Compare and contrast the relative strengths of futures contracts and options as hedging instruments (Max word count is 90 words) (9 marks) (d) Illustrate how banks can generate a profit by selling forward contracts (6 marks)