Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

What are the costs of alternatives for reducing short term foreign currency risk? Assume OSG has an account receivable of US$1 million. Use the information

What are the costs of alternatives for reducing short term foreign currency risk? Assume OSG has an account receivable of US$1 million. Use the information provided in Appendix 1 for this account's payable case of US$1 million to a US company. Which of the possible hedging methods presented in the case should OSG use if they expect the dollar to depreciate versus the yen during the next three months (the spot will be 110/$)? Use the information provided in Exhibit 10.

image text in transcribedimage text in transcribed

APPENDIX 1: FINANCIAL AND MARKET INFORMATION FOR THE CURRENCY EXPOSURE EXERCISE payment OSG makes the purchase of materials in US dollars at the end of April 2006, with due three months later in July 2006. Assume OSG's weighted average cost of capital is 5%. The accounting department collected the following information. Spot exchange rate: 115.03/$ Three-month forward rate: 116.18/$ Japan's three-month borrowing interest rate: 0.03% (or 0.0075% per quarter) Japan's three-month investment interest rate: 0.02% (or 0.005% per quarter) US three-month borrowing interest rate: 4% (or 1% per quarter) US three-month investment interest rate: 3.3% (or 1.1% per quarter) July call option in the over-the-counter (bank) market for US$1 million: strike price 115.77/$; 1.29% premium for three months. July put option in the over-the-counter (bank) market for US$1 million: strike price 115.77/$; 2.66% premium for three months. Po EXHIBIT 10: ACCOUNT RECEIVABLES, MINIMUM FORWARD: COVER BY A US CORPORATION 1. S. Corporation in the US did away with selective hedging. If the maturity of the transaction is known, all cash flow denominated in foreign currency must adhere to the forward contract cover formula determined by the company's board in advance. Remaining amounts, if any, may be left uncovered. The points, paying or receiving on the forward rate, are the forward rate's premium or discount defined by the formula in 2. Exposure Coverage Required 90-180 days Less than 90 days 45% "paying the points forward" "receiving the points forward" 75% 100% 180 days or longer 50% 60% 90% 2. Use the following formula to find the forward rate's premium or discount. The forward premium or discount is the percentage difference between the spot and forward exchange rate, stated in annual percentage terms. When the foreign currency price of the home currency (US dollar) is used as in this case of yen per dollar, the formula for the percent- per-annum premium or discount (denoted f here for yen) becomes:23 360 f*= Spot - Forward Forward x 100 days to maturity APPENDIX 1: FINANCIAL AND MARKET INFORMATION FOR THE CURRENCY EXPOSURE EXERCISE payment OSG makes the purchase of materials in US dollars at the end of April 2006, with due three months later in July 2006. Assume OSG's weighted average cost of capital is 5%. The accounting department collected the following information. Spot exchange rate: 115.03/$ Three-month forward rate: 116.18/$ Japan's three-month borrowing interest rate: 0.03% (or 0.0075% per quarter) Japan's three-month investment interest rate: 0.02% (or 0.005% per quarter) US three-month borrowing interest rate: 4% (or 1% per quarter) US three-month investment interest rate: 3.3% (or 1.1% per quarter) July call option in the over-the-counter (bank) market for US$1 million: strike price 115.77/$; 1.29% premium for three months. July put option in the over-the-counter (bank) market for US$1 million: strike price 115.77/$; 2.66% premium for three months. Po EXHIBIT 10: ACCOUNT RECEIVABLES, MINIMUM FORWARD: COVER BY A US CORPORATION 1. S. Corporation in the US did away with selective hedging. If the maturity of the transaction is known, all cash flow denominated in foreign currency must adhere to the forward contract cover formula determined by the company's board in advance. Remaining amounts, if any, may be left uncovered. The points, paying or receiving on the forward rate, are the forward rate's premium or discount defined by the formula in 2. Exposure Coverage Required 90-180 days Less than 90 days 45% "paying the points forward" "receiving the points forward" 75% 100% 180 days or longer 50% 60% 90% 2. Use the following formula to find the forward rate's premium or discount. The forward premium or discount is the percentage difference between the spot and forward exchange rate, stated in annual percentage terms. When the foreign currency price of the home currency (US dollar) is used as in this case of yen per dollar, the formula for the percent- per-annum premium or discount (denoted f here for yen) becomes:23 360 f*= Spot - Forward Forward x 100 days to maturity

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

ISE Foundations Of Financial Management

Authors: Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

18th International Edition

1265074658, 9781265074654

More Books

Students also viewed these Finance questions