Korean Airlines (KAL) has just signed a contract with Boeing to purchase two new
ID: 2724026 • Letter: K
Question
Korean Airlines (KAL) has just signed a contract with Boeing to purchase two new 747-400's for a total of $60,000,000, with a payment in two equal tranches. The first tranche of $30,000,000 has just been paid. The next $30,000,000 is due three months from today. KAL currently has excess cash of 25,000,000,000 won in Seoul bank, and it is from these funds that KAL plans to make its next payment. The current spot rate is W800/$, and permission has been obtained for a forward rate (90 days), W794/$. The 90-day eurodollar interest rate is 6.000%, while the 90-day Korean won deposit rate (there is no eurowon rate) is 5.000%. KAL can borrow in Korea at 6.250%, and can probably borrow in the U.S. dollar market at 9.375%. A three-month call option on dollars in the over-the-counter market, for a strike price of W790/$ sells at a premium of 1.9% (assuming a 12% volatility). KAL's foreign exchange advisory service forecasts the spot rate in three months to be W792/$. How should KAL plan to make the payment to Boeing if KAL's goal is to maximize the amount of won cash left in the bank at the end of the 3-month period? Make a recommendation and defend it.
Explanation / Answer
Conclusion:
KAL should borrow at eurodollar interest rate and deposit the W amount in korean bank at a interest rate of 5%. Case IV in the attached solution gives maximum profit to KAL. As no Eurdollar convertion rate is given I have assumed that euro dollar rate of 6 % is decisive rate.
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