Paragraph Styles DKNY owes 7 million Mexican pesos in 30 days for a recent shipm
ID: 2780626 • Letter: P
Question
Paragraph Styles DKNY owes 7 million Mexican pesos in 30 days for a recent shipment from Mexico. It faces the following interest and exchange rates: Spot rate: Forward rate (30 days): 30-day call option on pesos: Premium: US. dollar 30-day interest rate (annualized): 7.5% 13.0 pesos/$ 13.1 pesos/$ strike price E-1/12.9-0.07752 S/peso 0.00077 S/peso 1 Peso 30-day interest rate (annualized): 15% (a). What dollar cost of the payable can DKNY lock in using the forward contract? (b) What is the hedged dollar cost of DKNY's payable using a money market hedge? (c). What is the hedged dollar cost of DKNY's payable using a call option? (d). Supposc that DKNY expechs the 30-day spot rate to be 13.4 pesos/S. Should it hedge this payable?Explanation / Answer
Soln: a) Dollar cost booked in forward contract for Pesos = Value in Pesos/forward rate = 7/13.1 = $0.534 million
b) As DKNY needs to pay in pesos, borrow $X at 7.5% annualized for 30 days , now convert that currency into pesos i.e. X*spot rate *1.15*30/360 = 7 *10^6 , on claculation we get X = $5.62 million * 0.075/12 = $35117
c) Using call option for hedging , DKNY dollar cost = premium*value in pesos = 0.00077*7*10^6 = $5390
d) If spot rate = 13.4 pesos/$ then dollar value required (as calculated in b)= $34068 and if he is not hedging the same he need to pay more than that . So hedge is payable.
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