You are a U.S. exporter of soybeans and have just received an order from the U.K. You will deliver soybeans today to the buyer in the U.K. and receive a payment of 200,000 in one year. You are concerned about the dollar proceeds you will receive from this foreign sale in one year.

Suppose:

• Forward exchange rate is $1.40 per pound
• Spot exchange rate is $1.35 per pound
• U.S. interest rate is 3.00%
• U.K. interest rate is 5.00%

Call option with strike price of $1.40 per pound is available with premium of $0.08 per pound.

Put option with strike price of $1.40 per pound is available with premium of $0.10 per pound.

Required:

a-1. Unhedged Position: Suppose you decide not to do anything. In one year, the spot rate happens to be $1.45 per pound. What will be the total dollar proceeds from this sale then?

a-2. What will be the total dollar proceeds if the spot rate happens to be $1.30 per pound in one year?

a-3. What will be the total dollar proceeds if the spot rate happens to be $1.32 per pound in one year?

a-4. Are you subject to exchange rate risk if you remain unhedged?

b-1. Forward market hedge: How can you guarantee an exact amount of dollar proceeds from this sale using forward contracts? Should you agree to buy or sell 200,000 forward in one year?

b-2. What will be the total dollar proceeds from this sale with forward hedge?

b-3. Are you subject to exchange rate risk in this case?

c-1. Money market hedge: How can you ensure guaranteed dollar proceeds from this sale using money market hedge?

c-2. What will be the total dollar proceeds?

c-3. Are you subject to exchange rate risk when money market hedge is used?

d-1. Option market hedge: How can you hedge using options? Should you purchase call or put options on pounds?

d-2. What is the total premium due today?

d-3. What will be the total dollar proceeds if you exercise your options?

d-4. When will you not exercise your options and what will be the total dollar proceeds then?

e-1. Comparing hedging methods: What are the break-even exchange rates between the different hedging methods?

e-2. When do you prefer which hedging method?