Question
Vericity Corporation, located in the United States, has an accounts receivable of SF400 million due in one year from a firm in Switzerland. The current
Vericity Corporation, located in the United States, has an accounts receivable of SF400 million due in one year from a firm in Switzerland. The current spot rate is SF1.67/$ and the one year forward rate is SF1.58/$. The annual interest rate is 3.0% in Switzerland and 4.0% percent in the United States. Vericity can also buy a one-year put option on the Swiss franc at the strike price of $.6440 per Swiss franc for a premium of $0.005 per Swiss Franc.
a. Compute the guaranteed dollar proceeds at the time of payment if Vericity decides to hedge using a forward contract. Show your calculations.
b. Compute the guaranteed dollar proceeds at the time of payment if Vericity decides to hedge using a money market hedge. Show your calculations.
c. List the steps that Vericity needs to take in order to use a money market hedge to eliminate its transaction exposure. Be sure to include the time (t=0 or t=1 year) at which each step must be taken.
d. Suppose that Vericity decides to hedge using an option contract. Assume that the forward rate is the best predictor of the future spot rate. Is Vericity likely to exercise its option contract? Explain using the rates provided. (1 point)
e. Compute the expected dollar proceeds at the time of payment if Vericity decides to hedge using an option contract. Show your calculations. (3 points)
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