Question 6 - 24 marks On February 17, 2020, Alstom (a leading global train locomotives and systems manufacturer based in Paris, France) has signed a Memorandum of Understanding with Bombardier Inc (a Montreal, Canada-based company) to acquire all equity interests in Bombardier Transportation (the subsidiary in the similar line of business as Alstom) for USD 6.5 billion, of which USD 4.3 billion will be paid in cash and the remaining USD 2.2 billion in Alstom's shares. The transaction will be subject to approval by shareholders of both Alstom and Bombardier and regulatory approval, including anti-competition authorities. Alstom expects the acquisition to be completed by June 2021. In June 2020, Alstom's Treasurer met with his team to evaluate the various alternatives of hedging the currency exposures for the cash payments to Bombardier, assuming that the acquisition will indeed complete and payment will be made in June 2021. The money market interest rates and foreign exchange rates are given as follows: U.S. dollar one-year interest rate 0.4644% per year Euro one-year interest rate 0.0500% per year Spot exchange rate USD 1.1575 / EUR One-year forward exchange rate USD 1.1662 / EUR 6A. Assume that the EUR exchange rate against USD are freely traded and can fluctuate within a certain broad band. If Alstom uses forward contracts to hedge its exposure to USD 4.3 billion for delivery in 1 year. Indicate whether Alstom should use a long or short (EUR) forward contract to hedge its currency risk and why. (6A. 2 marks) 6B. If Alstom enters into a forward contract that expires in 1 year, what is its expected cost in EUR? (6B. 3 marks) 6C. Suppose Alstom uses a money market hedge. What currency and in what amount should it be borrowing or lending? (Hint: Use a chart to illustrate all cash flows of the transaction and financial contracts) (6C. 6 marks) 6D. Premium of the 1-year call option on EUR with an exercise price of EUR 1 = USD 1.1575 is USD 0.0066 / EUR and the 1-year put option on the USD with the same exercise price is USD 0.0097 / EUR. Should Alstom buy a call or a put option on EUR? What is the total option premium for Alstom in EUR? (6D. 4 marks)6E. If the spot rate at maturity (in 1 year's time) is EUR 1 = USD 1.1705, what is the total cost of the acquisition if Alstom decides to hedge using options in (D) above? (6E. 6 marks) 6F. What hedging method would you recommend to Alstom given the circumstances and why? (6F. 3 marks)