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CrayResearchsoldasupercomputertotheMaxPlanckInstituteinGermanyoncreditandinvoiced10millionpayableinsixmonths.Currently,thesix-monthforwardexchangerateis$1.10/andtheforeignexchangeadvisorforCrayResearchpredictsthatthespotrateislikelytobe$1.05/insixmonths.

1. Whatistheexpectedgain/lossfromtheforwardhedging?

2. If you were the financial manager of Cray Research, would you recommend hedging this euro receivable? Why or why not?

3. Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you recommend hedging in this case? Why or why not?

IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed 250 million payable in three months. Currently, the spot exchange rate is 105/$ and the three-month forward rate is 100/$. The three-month money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM decided to use the money market hedge to deal with this yen account payable.

Question:

1. Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation.

• DKNY owes 7 million Mexican pesos in 30 days for a recent shipment from Mexico. It faces the following interest and exchange rates:

Spot rate: 13.0 pesos/$

Forward rate (30 days): 13.1 pesos/$

30-day call option on pesos: strike price /12..07752 $/peso

Premium: 0.00077 $/peso

U.S. dollar 30-day interest rate (annualized): 7.5%

Peso 30-day interest rate (annualized): 15%

Questions:

(a). What dollar cost of the payable can DKNY lock in using the forward contract?

(b). What is the hedged dollar cost of DKNYs payable using a money market hedge?

(c). What is the hedged dollar cost of DKNYs payable using a call option?

(d). Suppose that DKNY expects the 30-day spot rate to be 13.4 pesos/$. Should

it hedge this payable?

1. Cray Research sold a super computer to the Max Planck Institute in Germany on credit and invoiced 10 million payable in six months. Currently, the six-month forward exchange rate is $1.10/ and the foreign exchange advisor for Cray Research predicts that the spot rate is likely to be $1.05/ in six months. Questions: (a) What is the expected gain/loss from the forward hedging? (b) If you were the financial manager of Cray Research, would you recommend hedging this euro receivable? Why or why not? (c) Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you recommend hedging in this case? Why or why not? 2. IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed 250 million payable in three months. Currently, the spot exchange rate is 105/$ and the three-month forward rate is 100/$. The three-month money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM decided to use the money market hedge to deal with this yen account payable. Question: Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation. 3. DKNY owes 7 million Mexican pesos in 30 days for a recent shipment from Mexico. It faces the following interest and exchange rates: Spot rate: 13.0 pesos/$ Forward rate (30 days): 13.1 pesos/$ 30-day call option on pesos: strike price E=1/12.9=0.07752 $/peso Premium: 0.00077 $/peso U.S. dollar 30-day interest rate (annualized): 7.5% Peso 30-day interest rate (annualized): 15% Questions: (a). What dollar cost of the payable can DKNY lock in using the forward contract? (b). What is the hedged dollar cost of DKNY's payable using a money market hedge? (c). What is the hedged dollar cost of DKNY's payable using a call option? (d). Suppose that DKNY expects the 30-day spot rate to be 13.4 pesos/$. Should it hedge this payable? 1 2