You are the manager of a U.S. company situated in Los Angeles and manages the import/export division of the company. The company distributes (resells) a variety of consumer products imported to the U.S.A from France and also exports goods manufactured in the U.S.A. to Britain. Therefore, your company is very much dependent on the impact of current and future exchange rates on the performance of the company. Scenario 1: You have to estimate the expected exchange rates one year from now between your home currency and the other currencies of the major other countries that you deal with in terms of both imports and exports. The reason is that increases in the values of other currencies compared to the U.S. Dollar may impact your imports negatively, whilst it may on the other hand, be good for exports. To do this estimate, you obtain the following spot exchange rate information: /$ /$ 0.76918 0.87616 You also obtain the following rates that you regard as similar to the annual risk free rates applying in the countries: U.S.A. Britain France 2.660% 0.778% 0.500% Your focus is presently to estimate the 12 month forward rates in order to consider the impact that it will have on the import and export sales of the company. Calculate the forward rates of the $ in terms of all the currencies by using simple interest rate parity e.g. 10% annual interest rate = 10/2 = 5% for six months. Do not apply effective annual interest rate compounding. Provide an indication about what will happen to the value of the US$ based on the forward exchange rate calculations by calculating the expected discount/premium of it for each of the currencies. Also show whether the impact will be positive (P) or negative (N) for imports and exports. For example: Exchange % Discount/Premium Import Export rate /$ Workings by you Positive Negative = 1.93% premium Table 4: France import cost with option hedge: (8 marks) Type of option (Call or put?) Total premium cost for import Total cost of option in $ (Strike plus premium) Show answers in this row: Show your workings in the columns below the answers $ premium x total Euro value of import x (1+i/n) Option hedge breakeven exchange rate (Strike price x total Euro value of import) + total premium Total cost of option in $/ Total Euro value of transaction Table 5: France: Exchange rate hedges compared: (3 marks) $/ Forward rate Money market hedge locked in exchange rate Option hedge breakeven exchange rate Which hedging technique should be applied? (3 marks) Table 6: Britain export with money market hedge: (8 marks) Show answers in this row: Show your workings in the columns below the answers PV of foreign currency to be borrowed Converted at spot to $ for investment $ amount with interest invested Exchange rate locked in with transaction Table 7: Britain exchange rate hedges compared: (2 marks) Forward rate Money market hedge locked in exchange rate $/ Which hedging technique should be applied? (3 marks) Page 3 of 4 Table 8: Value of the forward position (5 marks) Show answer in this row: ($ loss or gain for long/short position in forward) Show your workings in the columns below the answers