Assume that Wolverine expects to receive NZ$500,000 at the end of Year 1. The ex

Question

Assume that Wolverine expects to receive NZ$500,000 at the end of Year 1. The existing spot rate of the New Zealand dollar is $0.60, while the one-year forward rate is $0.62. Wolverine has created a probability distribution for the future spot rate in one year as follows:

Future Spot Rate

Probability

$0.61

20%

$0.63

50%

$0.67

30%

Assume that one-year put options on New Zealand dollars are available with an exercise price of $0.63 and a premium of $0.04 per unit. One-year call options on New Zealand dollars are available with an exercise price of $0.60 per unit. Assume the following money market rates:

United States

New Zealand

Deposit Rate

8%

5%

Borrowing Rate

9%

6%

Given the above information, determine whether a forward hedge, money market hedge, or currency options hedge would be most appropriate to mitigate currency risk. Then, compare your choice of hedging technique to an unhedged strategy and recommend whether Wolverine should hedge its receivables.

Future Spot Rate

Probability

$0.61

20%

$0.63

50%

$0.67

30%

Explanation / Answer

Amount receivable = NZ$500,000

Spot rate: 1NZ$ = $0.60

1-year forward rate: 1NZ$ = $0.62

Future Spot rate: 0.61x0.2 + 0.63x0.50 + 0.67x0.30 = $0.638

1. Forward: Under this alternative, the exporter will get 500000x0.62 = $310000

2. Money Market Operation:

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