Beck plc produces drill bits for gold mining equipment. A German customer is con
ID: 1721410 • Letter: B
Question
Beck plc produces drill bits for gold mining equipment. A German customer is contracted to pay Beck plc 8.5 million euros in six months' time. The top management of the company is thinking whether or not to hedge this foreign currency receipt, and if so, which method would be optimal. Some executives believe the exchange rate will be GBP1= EUR 1.37 when payment is due from the customer. Other executives think the exchange rate will be GBP1= EUR 1.43. The alternatives available to Beck pic are as follows; Forward contract hedge spot GBP/EUR Bid: 1.4010 Offer: 1.4132 6 month forward points 95/85 Currency option hedge Call option available: Strike GBP EUR 1.4200 at premium GBP 1.20 per EUR100 Put option available: Strike GBP EUR 1.4180 at premium GBP 1.00 per EUR100 To do nothing. Required: Calculate the net receipt in GBP under each of the three alternatives assuming the exchange rate in six months are GBP1=EUR 1.37 GBP1=EUR 1.43 Based on your answer in part a above, make a reasoned recommendation on which alternative is optical. Discuss the impact of the ISIS/terrorist attacks in continental Europe on the GBP/EExplanation / Answer
Answer (a)
The amount Beck Plc will receive from german contractor will be 8,500,000 euros
i) If rate is 1.37 EURO / 1.0 GBP
The amount in GBP = 8,500,000 / 1.37 = 6,204,380 GBP
ii) If rate is 1.43 EURO / 1.0 GBP
The amount in GBP = 8,500,000 / 1.43 = 5,944,056 GBP
Answer (b)
Now, we will evaluate given alternatives
The amount in GBP @ bid price = 8,500,000 / 1.4010 = 6,067,095 GBP
The amount in GBP @ offer price = 8,500,000 / 1.4132 = 6,014,718 GBP
So, the premium will be = 6,067,095 – 6,014,718 = 52,377 GBP
Call option available = Strike 1.4200 EURO / 1.0 GBP
Premium = 1.20 GBP / 100 EUR = (1.4200 * 1.2 )/(100) = 0.01704 EUR / 1 EUR
Total premium will be = (0.01704 * 8,500,000) = EURO 144,840
Ceiling price = 1.4200 + 0.01704 = 1.43704 EURO / 1.0 GBP
Put option available = Strike 1.4180 EURO / 1.0 GBP
Premium = 1.0 GBP / 100 EUR = (1.4180 * 1.0)/(100) = 0.01418 EUR / 1 EUR
Total premium will be = (0.01418 * 8,500,000) = EURO 120,530
Floor price = 1.4180 - 0.01418 = 1.40382 EURO / 1.0 GBP
From above we can see that alternative (b) will be optimal as premium is EURO 52,377 in forward contract hedge
Answer (c)
If, ISIS or terrorist attack happens in continental of Europe then the EURO will fall and it will be weaker than the earlier one. i.e. greater than current rate between 1.37 to 1.42.
In that case if Beck plc will receive amount in EURO from German contractor and GBP is stronger with EURO then Beck plc make less profit.
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