Jos Corporation is a SA-based firm and needs R600 000 to finance one of its expansion projects. It has no business in Switzerland but is considering one year financing in Swiss Francs, because the annual interest rate would be 5% in Switzerland Vs. 9% in South Africa. The spot rate of the Swiss Franc is presently R .6200, while the forward rate is R .6436.

1. Can Jackson benefit by borrowing Swiss Francs and simultaneously purchasing Francs one-year forward to cover the same contract to avoid exchange rate risk? Explain.
2. Assume that Jackson does not cover its exposure and expects that the Swiss Franc will appreciate by 5%, 3%, 2% and 1% all with an equal probability of occurrence. Use this information to determine the probability distribution of the effective financing rates. Show these how they would appear in a normal distribution curve.
3. Based on your findings above should Jackson finance with Swiss Francs? Explain.
4. Assume that Jackson does not cover its exposure and uses the forward rate to forecast the future spot rate. Determine the expected effective financing rate and comment whether Jackson's should finance with Swiss Francs. Explain.
5. What are the techniques a firm can use finance in a foreign currency and not necessarily be exposed to foreign exchange rate risk?
6. Why would a firm consider hedging net payables or net receivables with currency options rather than forward contracts? What are the disadvantages of hedging with currency options as opposed to futures contracts?
7. Explain how a firm trying to reduce its transaction exposure can use currency diversification.
8. Carbondale Company expects to receive SF 500, 000 in a year's time from Switzerland. The existing spot rate of the Swiss Franc is $.60/1SF. The one-year forward rate of the Swiss franc is $.62/1SF. Carbondale created a probability distribution for the future spot rate on SF in one year as follows:

Future Spot rate Probability

$.61 20%

$.63 50%

$.67 30%

Assume that a one-year put option (an option to sell) on francs is available, with an exercise price of $.63/1SF and a premium (price) of $.04 per unit. One-year call option on francs is available with an exercise price of $.60/1SF and a premium of $.03 per unit. Assume the following money Market rates.

US SWITZERLAND

Deposit rates 8% 5%

Borrowing rates 9% 6%

Given the above information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate (cost effective). Then compare the most appropriate hedge strategy to an un-hedged strategy, and decide whether Carbondale should hedge its payables position anyway.