国际财务管理课后习题答案chapter 8.doc 17页

'CHAPTER8MANAGEMENTOFTRANSACTIONEXPOSURESUGGESTEDANSWERSANDSOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMSQUESTIONS1.Howwouldyoudefinetransactionexposure?Howisitdifferentfromeconomicexposure?Answer:Transactionexposureisthesensitivityofrealizeddomesticcurrencyvaluesofthefirm’scontractualcashflowsdenominatedinforeigncurrenciestounexpectedchangesinexchangerates.Unlikeeconomicexposure,transactionexposureiswell-definedandshort-term.2.Discussandcomparehedgingtransactionexposureusingtheforwardcontractvs.moneymarketinstruments.Whendothealternativehedgingapproachesproducethesameresult?Answer:Hedgingtransactionexposurebyaforwardcontractisachievedbysellingorbuyingforeigncurrencyreceivablesorpayablesforward.Ontheotherhand,moneymarkethedgeisachievedbyborrowingorlendingthepresentvalueofforeigncurrencyreceivablesorpayables,therebycreatingoffsettingforeigncurrencypositions.Iftheinterestrateparityisholding,thetwohedgingmethodsareequivalent.3.Discussandcomparethecostsofhedgingviatheforwardcontractandtheoptionscontract.Answer:Thereisnoup-frontcostofhedgingbyforwardcontracts.Inthecaseofoptionshedging,however,hedgersshouldpaythepremiumsforthecontractsup-front.Thecostofforwardhedging,however,mayberealizedexpostwhenthehedgerregretshis/herhedgingdecision.4.Whataretheadvantagesofacurrencyoptionscontractasahedgingtoolcomparedwiththeforwardcontract?Answer:Themainadvantageofusingoptionscontractsforhedgingisthatthehedgercandecidewhethertoexerciseoptionsuponobservingtherealizedfutureexchangerate.Optionsthusprovideahedgeagainstexpostregretthatforwardhedgermighthavetosuffer.Hedgerscanonlyeliminatethedownsideriskwhileretainingtheupsidepotential.IM-17 5.SupposeyourcompanyhaspurchasedaputoptionontheGermanmarktomanageexchangeexposureassociatedwithanaccountreceivabledenominatedinthatcurrency.Inthiscase,yourcompanycanbesaidtohavean‘insurance’policyonitsreceivable.Explaininwhatsensethisisso.Answer:Yourcompanyinthiscaseknowsinadvancethatitwillreceiveacertainminimumdollaramountnomatterwhatmighthappentothe$/€exchangerate.Furthermore,iftheGermanmarkappreciates,yourcompanywillbenefitfromtherisingeuro.6.RecentsurveysofcorporateexchangeriskmanagementpracticesindicatethatmanyU.S.firmssimplydonothedge.Howwouldyouexplainthisresult?Answer:Therecanbemanypossiblereasonsforthis.First,manyfirmsmayfeelthattheyarenotreallyexposedtoexchangeriskduetoproductdiversification,diversifiedmarketsfortheirproducts,etc.Second,firmsmaybeusingself-insuranceagainstexchangerisk.Third,firmsmayfeelthatshareholderscandiversifyexchangeriskthemselves,renderingcorporateriskmanagementunnecessary.7.Shouldafirmhedge?Whyorwhynot?Answer:Inaperfectcapitalmarket,firmsmaynotneedtohedgeexchangerisk.Butfirmscanaddtotheirvaluebyhedgingifmarketsareimperfect.First,ifmanagementknowsaboutthefirm’sexposurebetterthanshareholders,thefirm,notitsshareholders,shouldhedge.Second,firmsmaybeabletohedgeatalowercost.Third,ifdefaultcostsaresignificant,corporatehedgingcanbejustifiablebecauseitreducestheprobabilityofdefault.Fourth,ifthefirmfacesprogressivetaxes,itcanreducetaxobligationsbyhedgingwhichstabilizescorporateearnings.8.Usinganexample,discussthepossibleeffectofhedgingonafirm’staxobligations.Answer:Onecanuseanexamplesimilartotheonepresentedinthechapter.IM-17 9.Explaincontingentexposureanddiscusstheadvantagesofusingcurrencyoptionstomanagethistypeofcurrencyexposure.Answer:Companiesmayencounterasituationwheretheymayormaynotfacecurrencyexposure.Inthissituation,companiesneedoptions,notobligations,tobuyorsellagivenamountofforeignexchangetheymayormaynotreceiveorhavetopay.Ifcompanieseitherhedgeusingforwardcontractsordonothedgeatall,theymayfacedefinitecurrencyexposure.10.Explaincross-hedginganddiscussthefactorsdeterminingitseffectiveness.Answer:Cross-hedginginvolveshedgingapositioninoneassetbytakingapositioninanotherasset.Theeffectivenessofcross-hedgingwoulddependonthestrengthandstabilityoftherelationshipbetweenthetwoassets.IM-17 PROBLEMS1.CrayResearchsoldasupercomputertotheMaxPlanckInstituteinGermanyoncreditandinvoiced€10millionpayableinsixmonths.Currently,thesix-monthforwardexchangerateis$1.10/€andtheforeignexchangeadvisorforCrayResearchpredictsthatthespotrateislikelytobe$1.05/€insixmonths.(a)Whatistheexpectedgain/lossfromtheforwardhedging?(b)IfyouwerethefinancialmanagerofCrayResearch,wouldyourecommendhedgingthiseuroreceivable?Whyorwhynot?(c)Supposetheforeignexchangeadvisorpredictsthatthefuturespotratewillbethesameastheforwardexchangeratequotedtoday.Wouldyourecommendhedginginthiscase?Whyorwhynot?Solution:(a)Expectedgain($)=10,000,000(1.10–1.05)=10,000,000(.05)=$500,000.(b)IwouldrecommendhedgingbecauseCrayResearchcanincreasetheexpecteddollarreceiptby$500,000andalsoeliminatetheexchangerisk.(c)SinceIeliminateriskwithoutsacrificingdollarreceipt,Istillwouldrecommendhedging.2.IBMpurchasedcomputerchipsfromNEC,aJapaneseelectronicsconcern,andwasbilled¥250millionpayableinthreemonths.Currently,thespotexchangerateis¥105/$andthethree-monthforwardrateis¥100/$.Thethree-monthmoneymarketinterestrateis8percentperannumintheU.S.and7percentperannuminJapan.ThemanagementofIBMdecidedtousethemoneymarkethedgetodealwiththisyenaccountpayable.(a)Explaintheprocessofamoneymarkethedgeandcomputethedollarcostofmeetingtheyenobligation.(b)Conductthecashflowanalysisofthemoneymarkethedge.Solution:(a).Let’sfirstcomputethePVof¥250million,i.e.,250m/1.0175=¥245,700,245.7SoiftheaboveyenamountisinvestedtodayattheJapaneseinterestrateforthreemonths,thematurityvaluewillbeexactlyequalto¥25millionwhichistheamountofpayable.Tobuytheaboveyenamounttoday,itwillcost:$2,340,002.34=¥250,000,000/105.Thedollarcostofmeetingthisyenobligationis$2,340,002.34asoftoday.(b)IM-17 ___________________________________________________________________TransactionCF0CF1____________________________________________________________________1.Buyyensspot-$2,340,002.34withdollars¥245,700,245.702.InvestinJapan-¥245,700,245.70¥250,000,0003.Payyens-¥250,000,000Netcashflow-$2,340,002.34____________________________________________________________________3.YouplantovisitGeneva,Switzerlandinthreemonthstoattendaninternationalbusinessconference.YouexpecttoincurthetotalcostofSF5,000forlodging,mealsandtransportationduringyourstay.Asoftoday,thespotexchangerateis$0.60/SFandthethree-monthforwardrateis$0.63/SF.Youcanbuythethree-monthcalloptiononSFwiththeexerciserateof$0.64/SFforthepremiumof$0.05perSF.Assumethatyourexpectedfuturespotexchangerateisthesameastheforwardrate.Thethree-monthinterestrateis6percentperannumintheUnitedStatesand4percentperannuminSwitzerland.(a)CalculateyourexpecteddollarcostofbuyingSF5,000ifyouchoosetohedgeviacalloptiononSF.(b)CalculatethefuturedollarcostofmeetingthisSFobligationifyoudecidetohedgeusingaforwardcontract.(c)Atwhatfuturespotexchangeratewillyoubeindifferentbetweentheforwardandoptionmarkethedges?(d)IllustratethefuturedollarcostsofmeetingtheSFpayableagainstthefuturespotexchangerateunderboththeoptionsandforwardmarkethedges.Solution:(a)Totaloptionpremium=(.05)(5000)=$250.Inthreemonths,$250isworth$253.75=$250(1.015).Attheexpectedfuturespotrateof$0.63/SF,whichislessthantheexerciseprice,youdon’texpecttoexerciseoptions.Rather,youexpecttobuySwissfrancat$0.63/SF.SinceyouaregoingtobuySF5,000,youexpecttospend$3,150(=.63x5,000).Thus,thetotalexpectedcostofbuyingSF5,000willbethesumof$3,150and$253.75,i.e.,$3,403.75.(b)$3,150=(.63)(5,000).(c)$3,150=5,000x+253.75,wherexrepresentsthebreak-evenfuturespotrate.Solvingforx,weobtainx=$0.57925/SF.Notethatatthebreak-evenfuturespotrate,optionswillnotbeexercised.IM-17 (d)IftheSwissfrancappreciatesbeyond$0.64/SF,whichistheexercisepriceofcalloption,youwillexercisetheoptionandbuySF5,000for$3,200.ThetotalcostofbuyingSF5,000willbe$3,453.75=$3,200+$253.75.$CostOptionshedgeForwardhedge$3,453.75$3,15000.5790.64(strikeprice)$/SF$253.75Thisisthemaximumyouwillpay.4.BoeingjustsignedacontracttosellaBoeing737aircrafttoAirFrance.AirFrancewillbebilled€20millionwhichispayableinoneyear.Thecurrentspotexchangerateis$1.05/€andtheone-yearforwardrateis$1.10/€.Theannualinterestrateis6.0%intheU.S.and5.0%inFrance.Boeingisconcernedwiththevolatileexchangeratebetweenthedollarandtheeuroandwouldliketohedgeexchangeexposure.(a)Itisconsideringtwohedgingalternatives:selltheeuroproceedsfromthesaleforwardorborroweurosfromtheCreditLyonnaiseagainsttheeuroreceivable.Whichalternativewouldyourecommend?Why?(b)Otherthingsbeingequal,atwhatforwardexchangeratewouldBoeingbeindifferentbetweenthetwohedgingmethods?Solution:(a)Inthecaseofforwardhedge,thefuturedollarproceedswillbe(20,000,000)(1.10)=$22,000,000.Inthecaseofmoneymarkethedge(MMH),thefirmhastofirstborrowthePVofitseuroreceivable,i.e.,20,000,000/1.05=€19,047,619.Thenthefirmshouldexchangethiseuroamountintodollarsatthecurrentspotratetoreceive:(€19,047,619)($1.05/€)=$20,000,000,whichcanbeinvestedatthedollarinterestrateforoneyeartoyield:$20,000,000(1.06)=$21,200,000.Clearly,thefirmcanreceive$800,000morebyusingforwardhedging.(b)AccordingtoIRP,F=S(1+i$)/(1+iF).Thusthe“indifferent”forwardratewillbe:F=1.05(1.06)/1.05=$1.06/€.IM-17 5.SupposethatBaltimoreMachinerysoldadrillingmachinetoaSwissfirmandgavetheSwissclientachoiceofpayingeither$10,000orSF15,000inthreemonths.(a)Intheaboveexample,BaltimoreMachineryeffectivelygavetheSwissclientafreeoptiontobuyupto$10,000dollarsusingSwissfranc.Whatisthe‘implied’exerciseexchangerate?(b)Ifthespotexchangerateturnsouttobe$0.62/SF,whichcurrencydoyouthinktheSwissclientwillchoosetouseforpayment?WhatisthevalueofthisfreeoptionfortheSwissclient?(c)WhatisthebestwayforBaltimoreMachinerytodealwiththeexchangeexposure?Solution:(a)Theimpliedexercise(price)rateis:10,000/15,000=$0.6667/SF.(b)IftheSwissclientchoosestopay$10,000,itwillcostSF16,129(=10,000/.62).SincetheSwissclienthasanoptiontopaySF15,000,itwillchoosetodoso.ThevalueofthisoptionisobviouslySF1,129(=SF16,129-SF15,000).(c)BaltimoreMachineryfacesacontingentexposureinthesensethatitmayormaynotreceiveSF15,000inthefuture.ThefirmthuscanhedgethisexposurebybuyingaputoptiononSF15,000.6.PrincessCruiseCompany(PCC)purchasedashipfromMitsubishiHeavyIndustry.PCCowesMitsubishiHeavyIndustry500millionyeninoneyear.Thecurrentspotrateis124yenperdollarandtheone-yearforwardrateis110yenperdollar.Theannualinterestrateis5%inJapanand8%intheU.S.PCCcanalsobuyaone-yearcalloptiononyenatthestrikepriceof$.0081peryenforapremiumof.014centsperyen.(a)Computethefuturedollarcostsofmeetingthisobligationusingthemoneymarkethedgeandtheforwardhedges.(b)Assumingthattheforwardexchangerateisthebestpredictorofthefuturespotrate,computetheexpectedfuturedollarcostofmeetingthisobligationwhentheoptionhedgeisused.(c)AtwhatfuturespotratedoyouthinkPCCmaybeindifferentbetweentheoptionandforwardhedge?Solution:(a)Inthecaseofforwardhedge,thedollarcostwillbe500,000,000/110=$4,545,455.Inthecaseofmoneymarkethedge,thefuturedollarcostwillbe:500,000,000(1.08)/(1.05)(124)=$4,147,465.(b)Theoptionpremiumis:(.014/100)(500,000,000)=$70,000.Itsfuturevaluewillbe$70,000(1.08)=$75,600.Attheexpectedfuturespotrateof$.0091(=1/110),whichishigherthantheexerciseof$.0081,PCCwillexerciseitscalloptionandbuy¥500,000,000for$4,050,000(=500,000,000x.0081).IM-17 Thetotalexpectedcostwillthusbe$4,125,600,whichisthesumof$75,600and$4,050,000.(c)Whentheoptionhedgeisused,PCCwillspend“atmost”$4,125,000.Ontheotherhand,whentheforwardhedgingisused,PCCwillhavetospend$4,545,455regardlessofthefuturespotrate.Thismeansthattheoptionshedgedominatestheforwardhedge.Atnofuturespotrate,PCCwillbeindifferentbetweenforwardandoptionshedges.7.Airbussoldanaircraft,A400,toDeltaAirlines,aU.S.company,andbilled$30millionpayableinsixmonths.Airbusisconcernedwiththeeuroproceedsfrominternationalsalesandwouldliketocontrolexchangerisk.Thecurrentspotexchangerateis$1.05/€andsix-monthforwardexchangerateis$1.10/€atthemoment.Airbuscanbuyasix-monthputoptiononU.S.dollarswithastrikepriceof€0.95/$forapremiumof€0.02perU.S.dollar.Currently,six-monthinterestrateis2.5%intheeurozoneand3.0%intheU.S.a.ComputetheguaranteedeuroproceedsfromtheAmericansaleifAirbusdecidestohedgeusingaforwardcontract.b.IfAirbusdecidestohedgeusingmoneymarketinstruments,whatactiondoesAirbusneedtotake?WhatwouldbetheguaranteedeuroproceedsfromtheAmericansaleinthiscase?c.IfAirbusdecidestohedgeusingputoptionsonU.S.dollars,whatwouldbethe‘expected’europroceedsfromtheAmericansale?AssumethatAirbusregardsthecurrentforwardexchangerateasanunbiasedpredictorofthefuturespotexchangerate.d.AtwhatfuturespotexchangeratedoyouthinkAirbuswillbeindifferentbetweentheoptionandmoneymarkethedge?Solution:a.Airbuswillsell$30millionforwardfor€27,272,727=($30,000,000)/($1.10/€).b.Airbuswillborrowthepresentvalueofthedollarreceivable,i.e.,$29,126,214=$30,000,000/1.03,andthensellthedollarproceedsspotforeuros:€27,739,251.ThisistheeuroamountthatAirbusisgoingtokeep.c.Sincetheexpectedfuturespotrateislessthanthestrikepriceoftheputoption,i.e.,€0.9091<€0.95,Airbusexpectstoexercisetheoptionandreceive€28,500,000=($30,000,000)(€0.95/$).Thisisgrossproceeds.Airbusspent€600,000(=0.02x30,000,000)upfrontfortheoptionanditsfuturecostisequalto€615,000=€600,000x1.025.ThustheneteuroproceedsfromtheAmericansaleis€27,885,000,whichisthedifferencebetweenthegrossproceedsandtheoptioncosts.d.Attheindifferentfuturespotrate,thefollowingwillhold:€28,432,732=ST(30,000,000)-€615,000.IM-17 SolvingforST,weobtainthe“indifference”futurespotexchangerate,i.e.,€0.9683/$,or$1.0327/€.Notethat€28,432,732isthefuturevalueoftheproceedsundermoneymarkethedging:€28,432,732=(€27,739,251)(1.025).SuggestedsolutionforMiniCase:ChaseOptions,Inc.[SeeChapter13forthecasetext]ChaseOptions,Inc.HedgingForeignCurrencyExposureThroughCurrencyOptionsHarveyA.PoniachekI.CaseSummaryThiscasereviewstheforeignexchangeoptionsmarketandhedging.Itpresentsvariousinternationaltransactionsthatrequirecurrencyoptionshedgingstrategiesbythecorporationsinvolved.Seventransactionsunderavarietyofcircumstancesareintroducedthatrequirehedgingbycurrencyoptions.Thetransactionsinvolvehedgingofdividendremittances,portfolioinvestmentexposure,andstrategiceconomiccompetitiveness.Marketquotationsareprovidedforoptions(andoptionshedgingratios),forwards,andinterestratesforvariousmaturities.II.CaseObjective.Thecaseintroducesthestudenttotheprinciplesofcurrencyoptionsmarketandhedgingstrategies.Thetransactionsareofvarioustypesthatoftenconfrontcompaniesthatareinvolvedinextensiveinternationalbusinessormultinationalcorporations.Thecaseinducesstudentstoacquirehands-onexperienceinaddressingspecificexposureandhedgingconcerns,includinghowtoapplyvariousmarketquotations,whichhedgingstrategyismostsuitable,andhowtoaddressexposureinforeigncurrencythroughcrosshedgingpolicies.III.ProposedAssignmentSolution1.ThecompanyexpectsDM100millioninrepatriatedprofits,anddoesnotwanttheDM/$exchangerateatwhichtheyconvertthoseprofitstoriseabove1.70.TheycanhedgethisexposureusingDMputoptionswithastrikepriceof1.70.Ifthespotraterisesabove1.70,theycanexercisetheoption,whileifIM-17 thatratefallstheycanenjoyadditionalprofitsfromfavorableexchangeratemovements.Topurchasetheoptionswouldrequireanup-frontpremiumof:DM100,000,000x0.0164=DM1,640,000.Withastrikepriceof1.70DM/$,thiswouldassuretheU.S.companyofreceivingatleast:DM100,000,000–DM1,640,000x(1+0.085106x272/360)=DM98,254,544/1.70DM/$=$57,796,791byexercisingtheoptioniftheDMdepreciated.Notethattheproceedsfromtherepatriatedprofitsarereducedbythepremiumpaid,whichisfurtheradjustedbytheinterestforegoneonthisamount.However,iftheDMweretoappreciaterelativetothedollar,thecompanywouldallowtheoptiontoexpire,andenjoygreaterdollarproceedsfromthisincrease.Shouldforwardcontractsbeusedtohedgethisexposure,theproceedsreceivedwouldbe:DM100,000,000/1.6725DM/$=$59,790,732,regardlessofthemovementoftheDM/$exchangerate.Whilethisamountisalmost$2millionmorethanthatrealizedusingoptionhedgesabove,thereisnoflexibilityregardingtheexercisedate;ifthisdatediffersfromthatatwhichtherepatriateprofitsareavailable,thecompanymaybeexposedtoadditionalfurthercurrentexposure.Further,thereisnoopportunitytoenjoyanyappreciationintheDM.IfthecompanyweretobuyDMputsasabove,andsellanequivalentamountincallswithstrikeprice1.647,thepremiumpaidwouldbeexactlyoffsetbythepremiumreceived.Thiswouldassurethattheexchangeraterealizedwouldfallbetween1.647and1.700.Iftheraterisesabove1.700,thecompanywillexerciseitsputoption,andifitfellbelow1.647,theotherpartywoulduseitscall;foranyrateinbetween,bothoptionswouldexpireworthless.Theproceedsrealizedwouldthenfallbetween:DM100,00,000/1.647DM/$=$60,716,454andDM100,000,000/1.700DM/$=$58,823,529.IM-17 Thiswouldallowthecompanysomeupsidepotential,whileguaranteeingproceedsatleast$1milliongreaterthantheminimumforsimplybuyingaputasabove.Buy/SellOptionsDM/$SpotPutPayoff“Put”ProfitsCallPayoff“Call”ProfitsNetProfit1.60(1,742,846)01,742,84660,716,45460,716,4541.61(1,742,846)01,742,84660,716,45460,716,4541.62(1,742,846)01,742,84660,716,45460,716,4541.63(1,742,846)01,742,84660,716,45460,716,4541.64(1,742,846)01,742,84660,716,45460,716,4541.65(1,742,846)60,606,0611,742,846060,606,0611.66(1,742,846)60,240,9641,742,846060,240,9641.67(1,742,846)59,880,2401,742,846059,880,2401.68(1,742,846)59,523,8101,742,846059,523,8101.69(1,742,846)59,171,5981,742,846059,171,5981.70(1,742,846)58,823,5291,742,846058,823,5291.71(1,742,846)58,823,5291,742,846058,823,5291.72(1,742,846)58,823,5291,742,846058,823,5291.73(1,742,846)58,823,5291,742,846058,823,5291.74(1,742,846)58,823,5291,742,846058,823,5291.75(1,742,846)58,823,5291,742,846058,823,5291.76(1,742,846)58,823,5291,742,846058,823,5291.77(1,742,846)58,823,5291,742,846058,823,5291.78(1,742,846)58,823,5291,742,846058,823,5291.79(1,742,846)58,823,5291,742,846058,823,5291.80(1,742,846)58,823,5291,742,846058,823,5291.81(1,742,846)58,823,5291,742,846058,823,5291.82(1,742,846)58,823,5291,742,846058,823,5291.83(1,742,846)58,823,5291,742,846058,823,5291.84(1,742,846)58,823,5291,742,846058,823,5291.85(1,742,846)58,823,5291,742,846058,823,529IM-17 Sincethefirmbelievesthatthereisagoodchancethatthepoundsterlingwillweaken,lockingthemintoaforwardcontractwouldnotbeappropriate,becausetheywouldlosetheopportunitytoprofitfromthisweakening.Theirhedgestrategyshouldfollowforanupsidepotentialtomatchtheirviewpoint.Therefore,theyshouldpurchasesterlingcalloptions,payingapremiumof:5,000,000STGx0.0176=88,000STG.Ifthedollarstrengthensagainstthepound,thefirmallowstheoptiontoexpire,andbuyssterlinginthespotmarketatacheaperpricethantheywouldhavepaidforaforwardcontract;otherwise,thesterlingcallsprotectagainstunfavorabledepreciationofthedollar.Becausethefundmanagerisuncertainwhenhewillsellthebonds,herequiresahedgewhichwillallowflexibilityastotheexercisedate.Thus,optionsarethebestinstrumentforhimtouse.HecanbuyA$putstolockinafloorof0.72A$/$.Sinceheiswillingtoforegoanyfurthercurrencyappreciation,hecansellA$callswithastrikepriceof0.8025A$/$todefraythecostofhishedge(infactheearnsanetpremiumofA$100,000,000x(0.007234–0.007211)=A$2,300),whileknowingthathecan’treceivelessthan0.72A$/$whenredeeminghisinvestment,andcanbenefitfromasmallappreciationoftheA$.Example#3:Problem:HedgeprincipaldenominatedinA$intoUS$.Forgoupsidepotentialtobuyfloorprotection.I.Hedgebywritingcallsandbuyingputs1)Writecallsfor$/A$@0.8025Buyputsfor$/A$@0.72#contractsneeded=PrincipalinA$/Contractsize100,000,000A$/100,000A$=1002)Revenuefromsaleofcalls=(#contracts)(sizeofcontract)(premium)$75,573=(100)(100,000A$)(.007234$/A$)(1+.0825195/360)3)Totalcostofputs=(#contracts)(sizeofcontract)(premium)$75,332=(100)(100,000A$)(.007211$/A$)(1+.0825195/360)4)PutpayoffIfspotfallsbelow0.72,fundmanagerwillexerciseputIfspotrisesabove0.72,fundmanagerwillletputexpireIM-17 5)CallpayoffIfspotrisesabove.8025,callwillbeexercisedIfspotfallsbelow.8025,callwillexpire6)NetpayoffSeefollowingTablefornetpayoffAustralianDollarBondHedgeStrikePricePutPayoff“Put”PrincipalCallPayoff“Call”PrincipalNetProfit0.60(75,332)72,000,00075,573072,000,2410.61(75,332)72,000,00075,573072,000,2410.62(75,332)72,000,00075,573072,000,2410.63(75,332)72,000,00075,573072,000,2410.64(75,332)72,000,00075,573072,000,2410.65(75,332)72,000,00075,573072,000,2410.66(75,332)72,000,00075,573072,000,2410.67(75,332)72,000,00075,573072,000,2410.68(75,332)72,000,00075,573072,000,2410.69(75,332)72,000,00075,573072,000,2410.70(75,332)72,000,00075,573072,000,2410.71(75,332)72,000,00075,573072,000,2410.72(75,332)72,000,00075,573072,000,2410.73(75,332)73,000,00075,573073,000,2410.74(75,332)74,000,00075,573074,000,2410.75(75,332)75,000,00075,573075,000,2410.76(75,332)76,000,00075,573076,000,2410.77(75,332)77,000,00075,573077,000,2410.78(75,332)78,000,00075,573078,000,2410.79(75,332)79,000,00075,573079,000,2410.80(75,332)80,000,00075,573080,000,2410.81(75,332)075,57380,250,00080,250,2410.82(75,332)075,57380,250,00080,250,2410.83(75,332)075,57380,250,00080,250,2410.84(75,332)075,57380,250,00080,250,2410.85(75,332)075,57380,250,00080,250,2414.TheGermancompanyisbiddingonacontractwhichtheycannotbecertainofwinning.Thus,theneedtoexecuteacurrencytransactionissimilarlyuncertain,andusingaforwardorfuturesasahedgeisinappropriate,becauseitwouldforcethemtoperformeveniftheydonotwinthecontract.IM-17 Usingasterlingputoptionasahedgeforthistransactionmakesthemostsense.Forapremiumof:12millionSTGx0.0161=193,200STG,theycanassurethemselvesthatadversemovementsinthepoundsterlingexchangeratewillnotdiminishtheprofitabilityoftheproject(andhencethefeasibilityoftheirbid),whileatthesametimeallowingthepotentialforgainsfromsterlingappreciation.5.SinceAMCinconcernedabouttheadverseeffectsthatastrengtheningofthedollarwouldhaveonitsbusiness,weneedtocreateasituationinwhichitwillprofitfromsuchanappreciation.Purchasingayenputoradollarcallwillachievethisobjective.ThedatainExhibit1,row7representa10percentappreciationofthedollar(128.15strikevs.116.5forwardrate)andcanbeusedtohedgeagainstasimilarappreciationofthedollar.Foreverymillionyenofhedging,thecostwouldbe:Yen100,000,000x0.000127=127Yen.Todeterminethebreakevenpoint,weneedtocomputethevalueofthisoptionifthedollarappreciated10percent(spotroseto128.15),andsubtractfromitthepremiumwepaid.Thisprofitwouldbecomparedwiththeprofitearnedonfiveto10percentofAMC’ssales(whichwouldbelostasaresultofthedollarappreciation).Thenumberofoptionstobepurchasedwhichwouldequalizethesetwoquantitieswouldrepresentthebreakevenpoint.IM-17 Example#5:HedgetheeconomiccostofthedepreciatingYentoAMC.IfweassumethatAMCsalesfallindirectproportiontodepreciationintheyen(i.e.,a10percentdeclineinyenand10percentdeclineinsales),thenwecanhedgethefullvalueofAMC’ssales.Ihaveassumed$100millioninsales.1)Buyyenputs#contractsneeded=ExpectedSales*Current¥/$Rate/Contractsize9600=($100,000,000)(120¥/$)/¥1,250,0002)TotalCost=(#contracts)(contractsize)(premium)$1,524,000=(9600)(¥1,250,000)($0.0001275/¥)3)Floorrate=Exercise–Premium128.1499¥/$=128.15¥/$-$1,524,000/12,000,000,000¥4)Thepayoffchangesdependingonthelevelofthe¥/$rate.Thefollowingtablesummarizesthepayoffs.Anequilibriumisreachedwhenthespotrateequalsthefloorrate.IM-17 AMCProfitabilityYen/$SpotPutPayoffSalesNetProfit120(1,524,990)100,000,00098,475,010121(1,524,990)99,173,66497,648,564122(1,524,990)98,360,65696,835,666123(1,524,990)97,560,97686,035,986124(1,524,990)96,774,19495,249,204125(1,524,990)96,000,00094,475,010126(1,524,990)95,238,09593,713,105127(847,829)94,488,18993,640,360128(109,640)93,750,00093,640,360129617,10493,023,25693,640,3601301,332,66892,307,69293,640,3601312,037,30791,603,05393,640,3601322,731,26990,909,09193,640,3601333,414,79690,225,66493,640,3601344,088,12289,552,23993,640,3601354,751,43188,888,88993,640,3601365,405,06688,235,29493,640,3601376,049,11887,591,24193,640,3601386,683,83986,966,52293,640,3601397,308,42586,330,93693,640,3601407,926,07585,714,28693,640,3601418,533,97785,106,38393,640,3601429,133,31884,507,04293,640,3601439,724,27683,916,08493,640,36014410,307,02783,333,33393,640,36014510,881,74082,758,62193,640,36014611,448,57982,191,78193,640,36014712,007,70781,632,65393,640,36014812,569,27981,081,08193,640,36014913,103,44880,536,91393,640,36015013,640,36080,000,00093,640,360IM-17 TheparenthasaDMpayable,andLirareceivable.Ithasseveralwaystocoveritsexposure;forwards,options,orswaps.TheforwardwouldbeacceptablefortheDMloan,becauseithasaknownquantityandmaturity,buttheLiraexposurewouldretainsomeofitsuncertaintybecausethesefactorsarenotassured.TheparentcouldbuyDMcallsandLiraputs.Thiswouldallowthemtotakeadvantageoffavorablecurrencyfluctuations,butwouldrequirepayingfortwopremiums.Finally,theycouldswaptheirLirareceivableintoDM.ThiswouldleaveanetDMexposurewhichwouldprobablybesmallerthantheamountoftheloan,whichtheycouldhedgeusingforwardsoroptions,dependingupontheirriskoutlook.ThecompanyhasLirareceivables,andisconcernedaboutpossibledepreciationversusthedollar.BecauseofthehighcostsofLiraoptions,theyinsteadbuyDMputs,makingtheassumptionthatmovementintheDMandLiraexchangeratesversusthedollarcorrelatewell.AhedgeoflirausingDMoptionswilldependontherelationshipbetweenliraFXratesandDMoptions.Thisrelationshipcouldbedeterminedusingaregressionofhistoricaldata.Thehedgedriskasapercentoftheopenriskcanbeestimatedas:SquareRoot(var(error)/(b2var(liraFXrate))*100The“cost”oftheriskoftheDMhedgewouldhavetobecomparedwiththecostoftheexpensiveliraoptions.Whicheverhedgeis“cheaper”(i.e.,lowercostforsameriskorlowerriskforsamecost)shouldbeselected.Thishedgemustbecloselymonitored,however,tomakesurethatthisrelationshipholdstrue.Ifitdoesnot,this“basisrisk”cancausetheratioofDMversusLiratochange,sothattheappropriateamountofcross-hedgeisdifferent.Ifthatamountisnotthenadjusted,anetcurrencyexposurecouldresult,leavingthecompanyopentoadditionalcurrencylosses.IM-17'