Exchange Rates: Today\'s spot exchange rate S 0 ($/DM) = 0.5019/0.5240 Exchange
ID: 2708765 • Letter: E
Question
Exchange Rates:
Today's spot exchange rate S0($/DM) = 0.5019/0.5240
Exchange rate available on 3 mo. future contracts F1/4($/DM) = 0.5028
The distributor's estimate of the spot exchange rate in 3 months S1/4($/DM) = 0.5050/0.5220
option information call option put option
contract size : DM62500 DM62500
Exercise price : $0.5050/DM $0.5090/DM
Premium : $0.0010/DM $0.0012/DM
Annual interest rate information US Rates(%) German Rates (%)
Invest: 5(US rate) 4(German rate)
Borrow : 8(US rate) 6(German rate)
a. If the distributor were to remain unhedged, how much would he expect to pay--in dollars--for the beer? Draw the payoff pattern.
b. If the distributor were to hedge this exposure with an option, which type of option would he use? Assuming that the distributor's estimate of the future spot rate is accurate, how many dollars would he pay for the beer?
c. If the distributor were to use a money market hedge, what would he expect to pay--in dollars--for the beer? (Use a diagram to explain your answer.)
d. Given your answers to the above questions, which would be the better way to hedge the distributor's currency risk?
Explanation / Answer
a) i'd buy beer for 0.5019/0.5240 *375,000 = $359184.16
b.) If i choose premium, amount to be paid=
$0.0010/DM $0.0012/DM *375,000 = 312,500$
I would want choose this because it is cheap when compared to other offers
c.) choose Exercise price : $0.5050/DM $0.5090/DM
the amount i would pay is $0.5050/DM $0.5090/DM*375000 = 372,053.0452$.
d)
Premium : $0.0010/DM $0.0012/DM is the best in terms of cost.
Exercise price : $0.5050/DM $0.5090/DM is best in terms of duty pay.
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