QUESTION 43 (25 marks)

Baton Rouge, a U.S. firm will need 1 million in one year to pay for its imports.

Given the following information:

360-day UK. borrowing interest rate

=6%

360-day U.K. deposit interest rate

= 4%

360-day U.S. borrowing interest rate

360-day U.S deposit interest rate

=3%

=2%

360-day forward rate of the British pound

= US$1.62

Spot rate of the British pound

= US$1.59

One-year call option: exercise price

One-year put option; exercise price

Expected one-year spot rate

= $1.60; premium = $0.03

= $1.61; premium = $0.04

= $1.63

Required:

i) What type of option should the firm use to hedge its payables.

(2 marks)

) Based your answer to part i, calculate the cost of using this option to hedge

the payables of 1,000,000?

(6 marks)

li) Showing and explaining all your workings, calculate the cost hedging of

million in payables, using the money market hedge.

(15 marks)

iv Should the furm use the options hedge or the money market hedge for its

payables? Justify your answer.

(2 marks)