Question
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
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 4,000 kilograms of frozen king crab for 100,000 euros (). There are three ways to convert the 100,000 euros (the sales revenue) to U.S. dollars ($) in one year: Convert directly in the spot market in one year. Enter into a one-year forward contract with a forward rate of $1.25/ today. Enter into a one-year put option to sell euros at a strike price of $1.25/ and pay the put price of $0.10/ today. Suppose that by the end of the year, a trade war erupts, leading to a European embargo on U.S. food products. As a result, your deal is cancelled, and you dont receive the euros from delivering the crab. What will be your profits (or losses) in U.S. dollars associated with each alternative? Write the profits in U.S. dollars as a function of the spot exchange rate S1 in one year for all alternatives. When there is a risk of cancellation, which type of hedge has the least downside risk? Explain briefly.
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