DEF Group. Is expected to receive £4.6 million from its UK customer in six month
ID: 2785303 • Letter: D
Question
DEF Group. Is expected to receive £4.6 million from its UK customer in six months The spot rate of pound is $1.2312/f The company's estimated distribution of exchange rate in six months is Prob. 0.1 0.4 0.5 Estimated Exchange Rate S/ 1.2012 1.2203 1.2480 The company is considering the following hedging tools. Forward contract with a forward rate of $1.2323/E. Futures with a rate of $1.2319/E. Notional amount is £62.500, Performance bond is $2,200 and maintenance is $1,100. Call options with strike of $1.2312/E, premium of $0.0069/ Put options with strike of $1.2312/, premium of $0.0037/ Calculate the expected payoff of forward hedge 2. 1. Calculate the expected payoff of futures hedge 3. Calculate the expected payoff of options hedge. 4. Compare the three hedging tools. Summarize the pros and cons. Exercise or not? Iype of option 5. Market rate S Strike rate S Exercise or not exercise Call Put Call Put Call Put Call Put 1.1231 1.1231 1.1231 1.2151 1.2302 1.6532 1.3360 2.2131 1.1251 1.1251 1.1231 1.2020 1.232 1.4562 1.3351 2.1313Explanation / Answer
Expected future spot rate after 6 months = 0.1*1.2012 + 0.4*1.2203 + 0.5*1.2480
= $1.2322
1. Forward hedge payoff = £4.6 million*$1.2323
= $5,668,580/-
2. Futures option:-
No.of contracts = £4.6 million/£62,500 = 73 contracts
Not covered under futures but forward covered for balance =
= (£4.6 million - 73*£62,500)*$1.2323
= $46,211.25/-
Intial performance bond = 73*$2,200 = $160,600
Maintenance bond = 73*$1,100 = $80,300
Loss from futures cover = [73 contracts*£62,500*($1.2322-1.2319)]
= $1,368.75
Actual receipt at actual future spot rate = 73*£62,500*1.2322
= $5,621,912.50
Add:- forward cover of balance = $46,211.25
Less:- loss on futures cover = $1,368.75
Net payoff from futures cover = $5,666,755/-
(3).Option hedge by future spot price = £4.6 million*$1.2322
= $5,668,120/-
Less= premium paid = £4.6 million*$0.0037 =$17,020
Net payoff = $5,651,100
Put option is not excercised at $1.2312 as it is lower than the future spot rate of $1.2322 which would realise less $ if put is excercised.
4. Forword cover is more practical as it realises more amount as compared to other hedging tools of futures and options.
5.
(a).Not excercised
(b).Excercised
(c).Exercised as the strike price and market price is same.
(d).Excercised
(e).Not excercised
(f).Not excercised
(g). Exercised
(h). Not excercised
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