Bobcat Company. Bobcat Company, U.S.-based manufacturer of industrial equipment,

Question

Bobcat Company. Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was Won7,400 million. Won1,000 million has already been paid, and the remaining Won6,400 million is due in six months. The current spot rate is Won1,106/S, and the 6-month forward rate is Won1,161/S. The 6-month Korean won interest rate is 16.5% per annum, the 6-month US dollar rate is 3% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A 6-month call option on won with a Won1 ,200/S strike rate has a 4.3% premium, while the 6-month put option at the same strike rate has a 3.8% premium. t can invest at the ates g ven above, or borrow at 2% per annum above those rate Bobcats we hted ave e cost of capital S or pare alternate ways e ow hat Bobcat igh dealwi it reign exchange exposure a. How much in U.S. dollars will Bobcat pay in 6 months without a hedge if the expected spot rate in 6 months is assumed to be Won1,106/S? Won1,161/S? b. How much in U.S. dollars will Bobcat pay in 6 months with a forward market hedge? How much in U.S. dollars will Bobcat pay in 6 months with a money market hedge? d. How much in U.S. dollars will Bobcat pay in 6 months with an option hedge if the expected spot rate in 6 months is assumed to be less than Won1,200/S? To be Won1,300/s? e. What do you recommend?

Explanation / Answer

a. Without Hedge:

1. if rate after 6 months is Won 1106 / $.

amount to be paid after 6 months = 6400 / 1106 = $ 5.79 million

2. if rate after 6 months is Won 1161 / $.

amount to be paid after 6 months = 6400 / 1161 = $ 5.51 million

b. Forward Market Hedge:

Amount to be paid after 6 months = 6400 / 1161 = $ 5.51 million

c. Money Market Hedge:

Implied Exchange rate using money market hedge: 1106 * [1+(16.5%*6/12)] / [(1+5%*6/12)] = 1168.

Since borrowing cost of BOB is 2% above given US Dollar Rate of 3%.

Amount to be paid after 6 months = 6400 / 1168 = $ 5.48 million

d. Option Hedge:

If rate after 6 months is less than 1200:

Exchange after after 6 months = Stike - Premium = 1200 - 1200*4.3% = 1148

Amount to be paid after 6 months = 6400 / 1148 = $ 5.57 million

If rate after 6 months is less than 1300:

Exchange after after 6 months = Rate after 6 months - Premium = 1300 - 1200*4.3% = 1248

Amount to be paid after 6 months = 6400 / 1248 = $ 5.13 million

e Recommendation = Option c is recommended. (Option d if rate after 6 months can go to 1300)

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