A Japanese MNC expects to receive a payment of €300,000 in 3 months. To hedge it
ID: 2712658 • Letter: A
Question
A Japanese MNC expects to receive a payment of €300,000 in 3 months. To hedge its foreign currency exposure, its CFO collects the following information: Current spot rate: ¥ 160/€,3-month forward rate: ¥ 158/€,€ interest rate per annum: 4%,¥ interest rate per annum: 1%,Put options written on € with an exercise price of ¥ 155/€ and 3-month maturity are prices at ¥ 3/€.
Questions: (6 questions in total)
(1) Construct a forward hedging for the MNC. Evaluate the result of forward hedging.
(2) Implement a money market hedging (MMH) for the MNC. Conduct cash flow analysis of the result of MMH.
(3) Conduct an option hedging for the MNC Evaluate the result of option hedging with the following probability distribution of future spot rate.
State 1
State 2
State 3
Probability
50%
30%
20%
Future Spot Rate
¥ 150/€
¥ 165/€
¥ 175/€
(4) At what future spot rate would the MNC be indifferent between option hedging and MMH? At what future spot rate would the MNC prefer MMH? Explain.
(5) At what forward rate would the MNC be indifferent between forward hedging and MMH? At what forward rate would the MNC prefer forward hedging? Explain.
(6) The MNC is currently reviewing price quotes by its foreign suppliers. Depending on the quote it finally accepts, the MNC will pay RMB 5,000,000 or WON 880,000,000 in 6 months. What hedging strategy should the MNC use in this situation?
State 1
State 2
State 3
Probability
50%
30%
20%
Future Spot Rate
¥ 150/€
¥ 165/€
¥ 175/€
Explanation / Answer
(1) MNC IS TO RECEIVE € 3,00,000 AFTER 3 MONTHS AND HENCE IS AFRAID OF € FALLING
SO TO HEDGE IN FORWARD MARKET MNC SHOULD SELL €3,00,000 FORWARD AT ¥158/€
SPOT RATE AFTER 3 MONTH= ¥ 159.5/€ (CALCULATED AS WEIGHTED AVERAGE OF DATA GIVEN IN POINT 3=¥ 150/€*50%+¥ 165/€*30%+¥ 175/€*20%)
LOSS DUE TO HEDGING=(¥ 159.5/€ - ¥ 158/€)*€3,00,000 =¥ 1.5/€ * €3,00,000 =¥ 4,50,000
(2) MONEY MARKET HEDGING
STEP 1:BORROW THE PRESENT VALUE OF €3,00,000 @ 4% P.A I.E 1%
AMOUNT TO BE BORROWED= €3,00,000/1.01=€2,97,030
STEP 2:SELL € 2,97,030 SPOT AT ¥ 160/€ GETTING
=¥4,75,24,800
STEP 3: THIS ¥4,75,24,800 IS INVESTED @ 1%P.A=0.25% FOR 3 MONTHS
INFLOW AFTER 3 MONTHS=¥4,75,24,800*1.0025=¥4,76,43,612
LOSS= €3,00,000*¥ 160/€ - ¥4,76,43,612
= ¥3,56,388
(3)EXPECTED FUTURE SPOT RATE=¥ 150/€*50%+¥ 165/€*30%+¥ 175/€*20%=¥ 159.5/€
=
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