5. You own a US company with borrowings from Switzerland. Over the next few mont
ID: 2816158 • Letter: 5
Question
5. You own a US company with borrowings from Switzerland. Over the next few months, your loan repayment of CHF 50 million is due. Given the foreign exchange market movements, you would like to minimise the impact on your cash outflow. Based on the following data, devise a suitable strategy. Evaluate your chosen strategy against suitable alternatives for a range of expected future spot rates. Spot rate 0.9888 CHF/USD 3 month forward rate 3 month future rate0.9796 CHF/USD Option Premia: Strike Price 0.9850 0.9900 Call Option 0.0108 0.0087 Put Option 0.0146 0.0175 Each option contract has a size of 125,000 Swiss Francs.Explanation / Answer
Since, we need Swiss Francs, we need to enter into Call Option contracts to buy Swiss Francs.
Total Swiss Francs needed = CHF 50 Million.
Contract size = 125,000
Number of contracts needed = 50,000,000 / 125,000
= 400
Spot Rate = 0.9888 CHF/USD
Value in USD, if Swiss Francs are purchased now = 50,000,000 / 0.9888
= $ 50,566,343.04
Considering Strike Price 0.9850,
Value in USD, if Swiss Francs are purchased = 50,000,000 / 0.9850
= $ 50,761,421.32
Amount to be paid for call options = 400 options * 0.0108
= $ 4.32
Total amount needed = 50,761,421.32 + 4.32
= $ 50,761,425.64.
Considering Strike Price 0.9900,
Value in USD, if Swiss Francs are purchased = 50,000,000 / 0.9900
= $ 50,505,050.51
Amount to be paid for call options = 400 options * 0.0087
= $ 3.48
Total amount needed = 50,505,050.51 + 3.48
= $ 50,505,053.99.
Since, total cash outflow is minimum, it is best to enter into Call Options Contracts at Strike Price of 0.9900.
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