QUESTION 1

a) Discuss the reasons of firms engage and disengage in hedging. (8 marks)

b) Explain the difference in the translation process between the monetary/nonmonetary method and the temporal method. (8 marks)

c) Suppose that Mac Machinery sold a drilling machine to a Swiss firm and gave the Swiss client a choice of paying either $10,000 or SF15,000 in three months.

i) In the example, Mac Machinery effectively gave the Swiss client a free option to buy up to $10,000 using Swiss francs. Calculate the "implied" exercise exchange rate. (2 marks)

ii) If the spot exchange rate turns out to be $0.62/SF, which currency do you think the Swiss client will choose to use for payment? Calculate the value of this free option for the Swiss client. (4 marks)

ii) Discuss the best way for Mac Machinery to deal with exchange exposure. (3 marks)