Multinational Finance, EIE 2005/06, problem set - IV
Question 1
Bush&sons - the U.S. chemical company - purchases pesticides from the British company. The purchase price is
GBP 1,000,000 with payment due in 3 months. The spot rate is USD 1.7600/GBP. The CFO suspects that pound may
appreciate, so he considers solutions to manage transaction exposure. The following data are available:
- 3-month forward rate USD 1.7540/GBP
- U.K. 3-month investment interest rate 8%p.a.
- Cost of capital is 8%
- Call option on British pounds at USD 1.7500/GBP (premium 1.5%).
Which hedging technique do you recommend and why?
Question 2
Lever Inc., of Phoenix has just purchased a Mexican company for UXN 60,000,000 with payment due in six months.
The spot exchange rate is UXN 5.4635/USD and the 6-month forward is UXN 5.6155/USD. Six-month interest rates on
peso and dollar are 9% p.a. and 4% p.a. (accordingly). Six-month call option on peso is available at UXN 5.4500/USD
and premium 3%. Six-month put option on peso is available at the same strike price, but premium is 2.4%. Lever Inc.
can invest at the given interest rates and borrow at interest rates one percentage point higher. Firm s weighted average
cost of capital is 24%. How Lever Inc. might deal with its foreign exchange exposure? What is the best alternative?
Question 3
Rotax, of Gunskirchen, Germany sold the aircraft engines to Boeing, of Chicago for USD 2,000,000 with payment due
in three months. The following quotes are available:
- Three-month interest rates (borrowing and investment) on U.S. dollar: 8% p.a.,
- Three-month interest rates (borrowing and investment) on euro: 6% p.a.,
- Spot exchange rate: USD 1.6000/EUR
- Three-month forward rate: USD 1.6120/EUR
- Three-month call option on U.S. dollar at USD 1.6000/EUR; premium 1%
- Three-month put option on U.S. dollar at USD 1.6000/EUR; premium 3%
- Rotax s cost of capital: 10%
a. Rotax wishes to protect euro value of receivable. What is the best choice?
b. What is the break-even reinvestment rate when comparing forward and money market alternatives?
Question 4
On October 1, Bumar Group, Poland concluded a deal with government of Malaysia on providing military equipment
for MYR 60,000,000, payable MYR 30,000,000 on January 1 and MYR 30,000,000 on April 1. Bumar quoted
contract s value in ringget by multiplying its zloty sales price of PLN 500,000 by the then current spot rate
MYR 120/PLN. As usual, Bumar s CFO considers different hedging technique to manage transaction exposure. The
following quotes were available:
- Borrowing interest rate on ringget: 3%p.a.
- Borrowing interest rate on zloty: 7.2%p.a.,
- Three-month forward rate: MYR 122/PLN
- Six-month forward rate: MYR 124/PLN
- January put option on ringget, strike price MYR 122/PLN, premium 2%
- April put option on ringget, strike price MYR 122/PLN, premium 2%
- January call option on ringget, strike price MYR 122/PLN, premium 3%
- April put option on ringget, strike price MYR 122/PLN, premium 2.6%
- Bumar s cost of capital: 24%p.a.
Decide what should Bumar s CFO do?
Question 5 (homework 3)
ABC Inc., of Radom, imports from XYZ, German company rough materials of EUR 1,000,000 with payment due in six
months. CFO predicts that euro may appreciate, so he decides to use contractual hedge. The following quotes are
available:
- Six-month forward exchange rate PLN 4.1000/EUR;
- Six-month investment interest rate on euro 8%p.a.;
- Six-month call option on euro at PLN 4.000/EUR, premium 1.5%
- ABC s cost of capital 10%p.a.
a. Which alternative would you recommend and why? Explain in detail.
b. What is the break-even forward exchange rate when comparing forward and option market alternatives?