Mini Case: Richard Mays Options It is Tuesday afternoon, February 14, 2012. Richard May, Assistant Treasurer at American Digital Graphics (ADG), sits in his office on the thirty-fourth floor of the building that dominates Rockefeller Plazas west perimeter. I must get this hedging memo done, thinks May, and get out of here. Foreign exchange options? I had better get the story straight before someone in the Finance Committee starts asking questions.

Before we delve any further into Richard Mays musings, let us learn a bit about ADG. ADG is a $12 billion sales company engaged in the development, manufacture, and marketing of microprocessorbased equipment. Although thirty percent of the firms sales are currently abroad, the firm has full-fledged manufacturing facilities in only three foreign countries, Germany, Canada, and Brazil. An assembly plant in Singapore exists primarily to solder Japanese semiconductor chips onto circuit boards and to screw these into Brazilian-made boxes for shipment to the United States, Canada, and Germany. The German subsidiary has developed half of its sales to France and the United Kingdom, billing in euros. The Hamburg office has automatic permission to repatriate 3 million by September 15th (in 214 days). Meanwhile, the firm has an agreement to buy 300,000 RAM chips at 8000 each semi-annually, and it is this payment that will fall due on June 10th (in 117 days).

Richard May is in his Rockefeller Center office, he has been printing spot, forward and currency options and futures quotations from the companys Bloomberg terminal. Looking at these prices, Richard realizes that he can work out how much the euro or yen would have to change to make the option worthwhile. Richard makes a mental note that ADG can typically borrow in the Eurocurrency market. Ill attach these numbers to my memo, mutters May, but the truth is he has yet to come to grips with the real question, which is when are currency options a better mean of hedging exchange risk for an international firm than traditional forward exchange contracts or futures contracts.

Please assist Mr. May in his analysis of currency hedging for his report to ADGs Finance Committee. (use 360 days in 1 year in the calculation)

a. For the future receivables, calculate the receiving from each of the forward, money market, and option hedging

b. For the future payables, calculate the receiving from each of the forward, money market, and option hedging

c. Calculate the breakeven exchange rate between forward and option hedging.

Relevant market data:

The current spot exchange rate S0=$1.3088/ 7-month forward exchange rate F7-month=$1.3090/ Dollar 1-year lending interest rate = 0.78% and euro 1-year borrowing interest rate = 2.40%. The strike price for put option on the euro = $1.3100 The put option premium = $0.0509/ .

The current spot exchange rate S0=$0.01274/ 4-month forward exchange rate F4-month=$0.01274/ Dollar 1-year borrowing interest rate = 0.62% and yen 1-year lending interest rate = 0.18%. The strike price for call option on the yen = $.0127/ The call option premium = $0.000311/