2. SMU Corp. has future receivables of 2,000,000 New Zealand dollars (NZ$) in on
ID: 2792782 • Letter: 2
Question
2. SMU Corp. has future receivables of 2,000,000 New Zealand dollars (NZ$) in one year. It must decide whether to use options or a money market hedge to hedge this position. Use any of the following information to make the decision. Verify your answer by determining the estimate (or probability distribution) of dollar revenue to be received in one year for each type of hedge.
Spot rate of NZ$ = $.54
Oneyear call option: Exercise price = $.50; premium = $.07
Oneyear put option: Exercise price = $.52; premium = $.03
U.S. New Zealand
Oneyear deposit rate 9% 6%
Oneyear borrowing rate 11 8
Rate Probability
Forecasted spot rate of NZ$ $.50 20%
.51 50
.53 30
Explanation / Answer
Answer :-
Put Option hedge (Excercise price = $ .52 : premium = $ 0.03)
Money market Hedge
1. Borrow NZ $ ( NZ $ 2000,000/1.08 = NZ $ 1851852)
2. Convert NZ $ 1851852 to $ 1000000 ( at $ 0.54 per New Zealand Dollar)
3. Invest $ 1000000 to accumulate $ 1090000 at the end of one year ( $ 1000000 x 1.09)
Possible Spot Put Option Premium Exercise Option Amount per unit Received (also accounting for premium) Total Amount Received for NZ $ 2000,000 Probability $ .50 $ .03 Yes $ .49 980000 20% $ .51 $ .03 Yes $ .49 980000 50% $ .53 $ .03 No $ .50 1000000 30%Related Questions
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