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Part A (10 Marks) Today is August 20th, the CFO of a corporation (based in Italy) knows that the company will receive $5 million USD
Part A (10 Marks) Today is August 20th, the CFO of a corporation (based in Italy) knows that the company will receive $5 million USD in four months, will receive 2.5 million pounds (sterling) in two months, and will pay 200 million Yen in three months. She wants to hedge, so she calls her contact at the bank and enters into several forward contracts immediately. (note: Italy's domestic currency is the Euro) a. Describe the positions that she should take to hedge exchange rate risk? Draw the payoff profiles for the unhedged positions and the forward contracts. b. If the Euro appreciates over the life of each contract, what will happen to the company's cash flows when each contract matures? Clearly state what assumptions you are making / have made. c. If the Euro depreciates over the life of each contract, what will happen to the company's cash flows when each contract matures? Clearly state what assumptions you are making / have made. Part B (5 Marks) You own a dividend paying stock that is currently trading at $50. You want to earn additional income by selling a call option. There are two call options with the same maturity date in two months that are available for you to sell. One of the call options has a strike price of $55 and the other has a strike price of $60. Which call option would you choose and why, if you believe the stock price has low volatility? Which call option would you choose and why, if you believe the stock price has high volatility? What other reasons would you choose one call option over the other? Draw a payoff diagram of the stock and call options respectively (note: the y-axis is the payoff and the x-axis is the stock price at maturity)
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