Question
You expect to receive $3,000,000 in six-months. The exact date for this receivable is June 1, 2019 (assume this is exactly in 120 days). You
You expect to receive $3,000,000 in six-months. The exact date for this receivable is June 1, 2019 (assume this is exactly in 120 days). You have compiled the following information: Spot rate: $1.15 per Euro or 0.8696 per $ 120-day forward rate: $1.18 per Euro or 0.8475 per $ 120-day US$ interest rate: 6% per annum 120-day Euro interest rate: 3% per annum 120-day call option on $ with a strike rate of 0.8696 and premium of 0.005 per $ 120-day call option on $ with a strike rate of 0.8475 and premium of 0.01 per $ 120-day put option on $ with a strike rate of 0.8696 and premium of 0.02 per $ 120-day put option on $ with a strike rate of 0.8475 and premium of 0.025 per $
a. Using the data above, how can the Irish company hedge its exposure? What are the cash flows associated with each method? (Assume that the options expire on the same day the receivable is due) Highlight the benefits and costs of each approach. (14 marks)
b. Suppose there is a June 2019 Euro futures contract. Each futures contract is for 125,000. The current futures price is 0.8696. The initial margin requirement on the futures contract is 2000 and the maintenance margin is 1500. Show how these futures contracts can be used to hedge the original exposure and highlight benefits and limitations of using futures contracts instead of forward contracts. (6 marks)
c. What are the three types of exchange rate exposure? Define each one and discuss how each one can be measured. Critically discuss whether or not each of these exposures should be managed and identify strategies/tools that a company can use to manage each type of exposure. (13.33 marks)
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