Managing Transaction Exposure Problems Your company is due to receive 1,000,000 in 6 months for a shipment of hi tech equipment just sent to a European country The current exchange rate is $1 11 , but because of global economic uncertainty and the monetary policy of the European Central Bank, you are concerned that the value of the Euro could dramatically change in a way that hurts your company Other information US interest rate is 2 5 Euro interest rate is 1 What change in the currency hurts you Appreciation of the Euro or Depreciation of the Euro What is the future value of your dollar receipts if you dont hedge Consider a range for the Euro from parity to $1 22 FORWARD HEDGE If you use a forward hedge, will you go LONG the Euro or will you SHORT the Euro Lets say you enter a Euro forward contract for 1 million at a forward rate of $1 122 What is the value of your dollar receipt in 6 months Consider an ending spot rate of $1 05 and $1 15 for the Euro What is the present value of your forward hedged receipt today (for both possible spot rates) if the appropriate discount rate is 4 per year OPTION HEDGE If you decide to hedge with an option contract, will you use a CALL or a PUT If you buy the appropriate at the money option and it has a premium of 1 8 of the notional amount, what is the payment you make today for the hedge Assume that the value of the Euro is either $1 05 or $1 15 by the end of the 6 months What do you receive based on your option in each situation That is, what proceeds do you get including the intrinsic value (but not including the premium) of the option What is the present value of your option transaction Include the premium paid at the start and the net proceeds you get in 6 months discounted at 4 per year MONEY MARKET HEDGE You decide to use a money market hedge Assume you can borrow and invest at the US Euro interest rates listed in the assumptions What currency will you borrow How much will you borrow today How much (and where) will you invest today What is the amount of dollars you will end up with after 6 months (consider both the $1 05 and $1 15 exchange rate) What is the present value of the receipt is you use a 4 annual discount rate What is the best strategy if the rate for the Euro is $1 05 in 6 months Forward hedge, option hedge, or money market hedge What is the best strategy if the rate for the Euro is $1 15 in 6 months Forward hedge, option hedge, or money market hedge

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Managing Transaction Exposure Problems Your company is due to receive 1,000,000 in 6 months for a shipment of hi-tech equipment just sent to a European

Managing Transaction Exposure Problems

Your company is due to receive 1,000,000 in 6 months for a shipment of hi-tech equipment just sent to a European country. The current exchange rate is $1.11/, but because of global economic uncertainty and the monetary policy of the European Central Bank, you are concerned that the value of the Euro could dramatically change in a way that hurts your company.

Other information: US interest rate is 2.5%

Euro interest rate is 1%

What change in the currency hurts you? Appreciation of the Euro or Depreciation of the Euro?
What is the future value of your dollar receipts if you dont hedge? Consider a range for the Euro from parity to $1.22/.

FORWARD HEDGE

If you use a forward hedge, will you go LONG the Euro or will you SHORT the Euro?
Lets say you enter a Euro forward contract for 1 million at a forward rate of $1.122. What is the value of your dollar receipt in 6 months? Consider an ending spot rate of $1.05 and $1.15 for the Euro.
What is the present value of your forward-hedged receipt today (for both possible spot rates) if the appropriate discount rate is 4% per year?

OPTION HEDGE

If you decide to hedge with an option contract, will you use a CALL or a PUT?
If you buy the appropriate at-the-money option and it has a premium of 1.8% of the notional amount, what is the payment you make today for the hedge?
Assume that the value of the Euro is either $1.05 or $1.15 by the end of the 6 months. What do you receive based on your option in each situation? That is, what proceeds do you get including the intrinsic value (but not including the premium) of the option?
What is the present value of your option transaction? Include the premium paid at the start and the net proceeds you get in 6 months discounted at 4% per year.

MONEY MARKET HEDGE

You decide to use a money market hedge. Assume you can borrow and invest at the US/Euro interest rates listed in the assumptions. What currency will you borrow?
How much will you borrow today?
How much (and where) will you invest today?
What is the amount of dollars you will end up with after 6 months (consider both the $1.05 and $1.15 exchange rate)?
What is the present value of the receipt is you use a 4% annual discount rate?

What is the best strategy if the rate for the Euro is $1.05 in 6 months? Forward hedge, option hedge, or money market hedge?

What is the best strategy if the rate for the Euro is $1.15 in 6 months? Forward hedge, option hedge, or money market hedge?