A US importer is concerned about the appreciation of EUR against USD due to EUR
ID: 2802080 • Letter: A
Question
A US importer is concerned about the appreciation of EUR against USD due to EUR payables of EUR210,000,000 in three months. To hedge the position, importer decides to use futures markets. Currently, CME (Chicago Mercantile Exchange) EUR contracts (125,000 each) with the closest maturity are traded at USD1.2100 per EUR. The futures contract will expire one week after the due date of payables. Suppose the importer takes a futures position equal to EUR100 million of its cash position at USD1.2100. Also, Company treasurer buys an OTC (over the counter) call option on EUR for EUR 100,000,000 notional with a strike price of EUR/USD 1.2 100 at 1% premium and leaves EUR!0,000,000 portion of the exposure uncovered. At the time the option is purchased, the spot rate was USD1.1990. On the day the Futures contract is liquidated, the Futures price is 1.2325 per EUR and the EUR/USD spot rate is 1.2300. Calculate the effective amount of USD the company wil pay for its 210m EUR payable? Assume that importer's cost of capital is 10%. [Round your numbers into integers]Explanation / Answer
Premium Paid for the Option = 100 Million EUR * spot rate on purchase date *1%= 100,000,000*1.199*1%=$1,199,000
But since future contract was liquidated earlier than expiry and at future rate of 1.2325 per EUR, the gain from the future contract = (1.2325 - 1.2100)*100,000,000= $2,250,000
Value of 100 Million EUR @1.23 per EUR spot rate on liquidation date = 100,000,000*1.23 = $123,000,000
Value of 100 Million EUR hedged through option @ strike price 1.21 per EUR = 100,000,000*1.21 = $121,000,000
10,000,000 EUR @ 1.23 per EUR spot rate on liquidation date = 10,000,000*1.23 = 12,300,000
Therefore effective USD outflow for the company = $12,300,000+$121,000,000+$123,000,000+1,199,000(option premium)- $2,250,000(gain from future hedging)= $255,249,000
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