Narto Co. (a U.S. firm) exports to Switzerland and expects to receive 500,000 Sw

Question

Narto Co. (a U.S. firm) exports to Switzerland and expects to receive 500,000 Swiss francs in 1 year. The 1-year U.S. interest rate is 5 percent when investing funds and 7 percent when borrowing funds. The 1-year Swiss interest rate is 9 percent when investing funds and 11 percent when borrowing funds. The spot rate of the Swiss franc is $.80. Narto expects that the spot rate of Swiss franc will be $.75 in 1 year. There is a put option available on Swiss francs with an exercise price of $.79 and a premium of $.02

a. Determine the amount of dollars that Narto Co. will receive at the end of 1 year if it implements a money market hedge.

b. Determine the amount of dollars that Narto Co. expects to receive at the end of 1 year (after accounting for the option premium) if it implements a put option hedge.

Explanation / Answer

a)Calculation of amount of dollars received , if money market hedge is implemented:

Calculate number of swiss francs to be borrowed:

Number of swiss francs=500000/1.11=450450.45

Conversion of swiss francs to dollars=45045.04*.80=360360.36

Invest the dollars=360360.36*1.05=378378.4

Therefore amount of dollars to be received if the money market hedge is implemented is 378378.4.

b)Calculate amount of dollars expected to receive if put option is implemented:

Amount*(exercise price-premium)

=500000*(0.79-0.02)=385000

Therefore amount of dollars expected to be received if put options is implemented is 385000

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