3. You are buying a boat from a company that builds custom boats. You would like

Question

3. You are buying a boat from a company that builds custom boats. You would like a boat priced at $60,000 for delivery June 15, 2018. As the company you are buying from operates from an offshore island location, they prefer all payments be in Bitcoin. You negotiate a deal with the company to buy the boat for $6,000 in cash today as a downpayment and a payment of 5 Bitcoins in June 2018 when the boat is delivered.

(a) Explain the currency risk you are taking with this contract

(b) Describe (in general) 2 ways of hedging the risk in the transaction above. (Note you can assume standard derivative contracts are available).

(c) Describe (in general) 2 ways the seller of the boat can hedge the above contract

Explanation / Answer

1-As payment is being done in two mode

-6000 in cash today

-54000 in 5 bitcoin in 6 month from now i.e June 2018

Now here the risk is with exchange rate of BITCOIN/USD.today it might seems that we need to pay only 54k but this value depends on future value of BitcoinLets assume if Bitcoin appreciate to become $12000 in June 2018 then transaction will be like

1-Get 60k(12K*5 bitcoin) out of bank

2-Convert it on Bitcoin exchange to get 5 bitcoin

3-Give it to boat seller

So buyer is at risk of paying more if bitcoin appreciate.

2)Buy bitcoin futures- Bitcoin futures has been introduced on some exchanges and if I buy a bitcoin future then any price increase/decrease will not affect initial value of my contract

Scenario one – bitcoin goes to12000 –assume current price 10.8k(54/5)

Loss in contract -6k

Gain in future 6k

So loss on gain is zero.

Same will happen when bitcoin price goes down to 10 k

Gain in contract -4k as he will be paying only 50k

Loss in future 4 k

Second way to hedge is to buys bitcoin directly from exchanges.

3)Seller of the boat faces the same risk but from the opposite direction of the buyer.so he need to sell the future of bitcoin or he can short sell bitcoin on exchanges. there are trading platform like kraken provide this facility.

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