6. Elaine Corporation sold equipment to an Argentine firm. Elaine Corp. will rec

Question

6. Elaine Corporation sold equipment to an Argentine firm. Elaine Corp. will receive ARS 2.000,000 in 180 days (ARS-Argentine peso). It considers using (1) a forward hedge, (2) an option hedge, (3) a money market hedg (4) no hedge. Its analysts develop the following information, which can be used to assess the alternative solutions: Spot rate .30 USD/ARS . 180-day forward rate .32 USD/ARS Annual interest rates are as follows: deposit rate: 10% in Argentina, and 5% in the US. borrowing rate: 12 5% in Argentina, and 5.5% in the US. A call option on ARS that expires in 180 days has an exercise price of USD .32 and a premium of USD.02. . A put option on ARS that expires in 180 days has an exercise price of USD.31 and a premium of USD.03. Elaine Corporation forecasted the future spot rate in 180 days as follows: Possible Outcomes 28 USD/ARS 31 USD/ARS 35 USD/ARS Probability 10% 60% 30% Which strategy would you recommend to Elaine Corporation? Why? Be explicit.

Explanation / Answer

Future spot rate in 180days A B C=A*B Posssible outcomes(USD/ARS) Probability (Outcome)*(Probability) 0.28 10% 0.028 0.31 60% 0.186 0.35 30% 0.105 SUM 0.319 Expected spot rate in 180days 0.319 Amount expected to be received with no hedge $        638,000 (2000000*0.319) .(1) FORWARD HEDGE 180days forward rate 0.32 USD/ARS Amount to be received in 180 days $                  640,000 (2000000*0.32) .(2) OPTION HEDGE BUY PUT OPTION: Quantity of Put Options bought                      640,000 (2000000*0.32) exercise price 0.32 USD Premium paid $                    19,200 (0.03*640000) Gain on put option with expected price=0.319 $                    640.00 (0.32-0.319)*640000 Net Loss $                    18,560 Net Recepit $                  619,440 (638000-18560) .(3) MONEY MARKET HEDGE Current Spot Rate(USD/ARS) 0.30 Borrowing Rate in Argentina 12.50% Interest for 180days=12.5/2= 6.25% Present value of receivable            1,882,352.94 (2000000/(1.0625) Amount tobe borrowed in ARS            1,882,352.94 Amount received on conversion $            564,705.88 (1882353*0.30) Amount invested in US $            564,705.88 US interest rate on deposit 5% 180 days interest 2.50% Amount tobe received after 180days withinterest $                  578,824 (564705.88*(1.025) Net Amount of receipt 1 Forward Hedge $                  640,000 2 Option Hedge $                  619,440 3 Money market Hedge $                  578,824 4 No Hedge $                  638,000 Recommended Strategy: Forward Hedge This provides maximum amount in USD

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