You are a broker for frozen seafood products for Choyce Products. You just signed a deal with a Belgian distributor. Under the terms of the contract, in one year you will deliver 4,500 kilograms of frozen king crab for 105,000 euros. Your cost for obtaining the king crab is $108,000. All cash flows occur in exactly one year a) Plot your profits in one year from the contract as a function of the exchange rate in one year, for each exchange rate at $0.25/ increments from $0.75/ to $1.50/. Label this line "Unhedged Profits." b) Suppose the one-year forward exchange rate is $1.25/ and that you enter into a forward contract to sell the euros you will receive at this rate. In the figure from part (a), plot your combined profits from the crab contract and the forward contract as a function of the exchange rate in one year. Label this line "Forward Hedge." c) Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy euros at a strike price of $1.25/ is trading for $0.19/. Similarly a one year put option to sell euros at a strike price of $1.25/ is trading for $0.19/. To hedge the risk of your profits, should you buy or sell the call or the put? (Hint: You want to protect your dollar profits from falling when the S/ exchange rate decreases.) In the figure from parts (a) and (b), plot your "all in" profits using the option hedge (combined profits of crab contract, option contract, and option price) as a function of the exchange rate in one year. Label this line "Option Hedge." (Hint: Note that when you buy an option, you pay the option price and when you sell an option, you receive the option price. Ignore the effect of interest on the option price.) d) You are a broker for frozen seafood products for Choyce Products. You just signed a deal with a Belgian distributor. Under the terms of the contract, in one year you will deliver 4,500 kilograms of frozen king crab for 105,000 euros. Your cost for obtaining the king crab is $108,000. All cash flows occur in exactly one year a) Plot your profits in one year from the contract as a function of the exchange rate in one year, for each exchange rate at $0.25/ increments from $0.75/ to $1.50/. Label this line "Unhedged Profits." b) Suppose the one-year forward exchange rate is $1.25/ and that you enter into a forward contract to sell the euros you will receive at this rate. In the figure from part (a), plot your combined profits from the crab contract and the forward contract as a function of the exchange rate in one year. Label this line "Forward Hedge." c) Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy euros at a strike price of $1.25/ is trading for $0.19/. Similarly a one year put option to sell euros at a strike price of $1.25/ is trading for $0.19/. To hedge the risk of your profits, should you buy or sell the call or the put? (Hint: You want to protect your dollar profits from falling when the S/ exchange rate decreases.) In the figure from parts (a) and (b), plot your "all in" profits using the option hedge (combined profits of crab contract, option contract, and option price) as a function of the exchange rate in one year. Label this line "Option Hedge." (Hint: Note that when you buy an option, you pay the option price and when you sell an option, you receive the option price. Ignore the effect of interest on the option price.) d)
