QUESTIONS FOUR (30 MARKS) a) Plains States Manufacturing, a U.S. manufacturing firm has just signed a contract to sell agricultural equipment to Boschin, a German firm, for 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in Euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. The spot exchange rate is $1.1740/ The six-month forward rate is $1.1600/ The Euro zone 6-month borrowing rate is 3.5% for 6 months The Euro zone 6-month deposit rate is 2.5% for 6 months The U.S. 6-month borrowing rate is 3% for 6 months The U.S. 6-month deposit rate is 2.25% for 6 months December put options for 625,000; strike price $1.18, and premium price is $0.015 . i) If Plains States chooses to hedge its transaction exposure in the forward market, what is the payoff in six months? (2 marks) ii) iii) Plains States could hedge the Euro receivables in the money market. Using the information provided how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate? (6 marks) Determine the expected amount to be received if Plains States purchased the put option with the following probability distribution for the spot rate in six months. (7 marks) Future spot rate Probability $1.1650/ 30% $1.1800/ 40% $1.1950/ 30% b) Sembo Co. is a China-based company with businesses in China and Malaysia. In attempting to assess its economic exposure, it compiled the following information. Sembo's forex risk is affected by the volatility of Malaysian Ringgit (MYR), because approximately 40% of its total sales in RMB are generated from the Malaysia subsidiary. The forecasted sales are based on the following three exchange rate scenarios: Exchange rates China-based sales in RMB Malaysia-based sales in MYR RMB1.50/MYR 850 250 RMB1.55/MYR 785 300 RMB1.60/MYR 690 350 The cost of materials is forecasted as follows: Exchange rates Purchase in RMB Purchase in MYR RMB1.50/MYR 400 200 RMB1.55/MYR 375 225 RMB1.60/MYR 350 250 Operating variable costs are estimated at 20% of the total sales in RMB (Hint: total sales include Malaysia-based sales in RMB). Fixed operating costs are estimated at RMB100 million. i) Forecast net cash flows for Sembo Co under each of the three exchange rate scenarios. (9 marks) ii) Explain how Sembo's projected net cash flows are affected by possible exchange rate movements and if there is a need to restructure its operations to reduce the sensitivity of its net cash flows to exchange rate movements. (6 marks) QUESTIONS FOUR (30 MARKS) a) Plains States Manufacturing, a U.S. manufacturing firm has just signed a contract to sell agricultural equipment to Boschin, a German firm, for 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in Euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. The spot exchange rate is $1.1740/ The six-month forward rate is $1.1600/ The Euro zone 6-month borrowing rate is 3.5% for 6 months The Euro zone 6-month deposit rate is 2.5% for 6 months The U.S. 6-month borrowing rate is 3% for 6 months The U.S. 6-month deposit rate is 2.25% for 6 months December put options for 625,000; strike price $1.18, and premium price is $0.015 . i) If Plains States chooses to hedge its transaction exposure in the forward market, what is the payoff in six months? (2 marks) ii) iii) Plains States could hedge the Euro receivables in the money market. Using the information provided how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate? (6 marks) Determine the expected amount to be received if Plains States purchased the put option with the following probability distribution for the spot rate in six months. (7 marks) Future spot rate Probability $1.1650/ 30% $1.1800/ 40% $1.1950/ 30% b) Sembo Co. is a China-based company with businesses in China and Malaysia. In attempting to assess its economic exposure, it compiled the following information. Sembo's forex risk is affected by the volatility of Malaysian Ringgit (MYR), because approximately 40% of its total sales in RMB are generated from the Malaysia subsidiary. The forecasted sales are based on the following three exchange rate scenarios: Exchange rates China-based sales in RMB Malaysia-based sales in MYR RMB1.50/MYR 850 250 RMB1.55/MYR 785 300 RMB1.60/MYR 690 350 The cost of materials is forecasted as follows: Exchange rates Purchase in RMB Purchase in MYR RMB1.50/MYR 400 200 RMB1.55/MYR 375 225 RMB1.60/MYR 350 250 Operating variable costs are estimated at 20% of the total sales in RMB (Hint: total sales include Malaysia-based sales in RMB). Fixed operating costs are estimated at RMB100 million. i) Forecast net cash flows for Sembo Co under each of the three exchange rate scenarios. (9 marks) ii) Explain how Sembo's projected net cash flows are affected by possible exchange rate movements and if there is a need to restructure its operations to reduce the sensitivity of its net cash flows to exchange rate movements. (6 marks)