Use the following for Questions 2 through 5: In June U.S.A. Manufacturing Inc. s

ID: 2756028 • Letter: U

Question

Use the following for Questions 2 through 5: In June U.S.A. Manufacturing Inc. signs contract to sell agricultural equipment to Bosche, a German firm, for EUR 5,000,000. Payment is due six months later in December. U.S. A. Manufacturing is considering several hedging alternatives to reduce the exchange rate risk arising from the sale based on the following information: The spot exchange rate is $1,3320/euro The six month forward rate is $13365/euro U.S.A. Manufacturing Inc.'s cost of capital (WACC) is 10% In the euro zone U.S.A. Manufacturing Inc.'s borrowing rate is 6% per annum (pa) (or 3.0% for 6 months) and it can lend or invest at 5% pa (or 2.50% for 6 months) In the US U.S.A. Manufacturing Inc.'s borrowing rate is 7% pa (or 3.5% for 6 months) and it can lend or invest at 6.5% pa (or 3.25% for 6 months) December put option contracts for 125,000 each are available as follows: U.S.A. Manufacturing Inc.'s forecast for 6-month spot rates is $1.3350/euro The lowest acceptable USD sales price for this contract is $6,250,000. If U.S.A. Manufacturing Inc. chooses to hedge its transaction exposure in the forward market at the available forward rate, how much will U.S.A. Manufacturing receive? If U.S.A. Manufacturing chooses to implement a money market hedge for the Euro receivables, how much money in which currency will the firm borrow today?

Explanation / Answer

Answer 2

If the USA manufacturing Inc chooses to hedge in forward market the money it will receive at the end of six month is equal to : forward rate * Sales amount in Euro

= 1.3365 * 5000000 = $ 6682500

Answer 3

If the USA manufacturing company uses money market hedge then company will have to borrow in $ to pay for the contract price. Borrowing under all three Put option is given below:

Put1

Put2

Put 3

Strike Price

1.335

1.3

1.25

Cost per contract

7037.5

4487.5

2837.5

Number of contract

Total cost of contract

28150

17950

11350

USA company will be Borrowing in dollars today

$ 28150

$ 17950

$ 11350