You own a US company with borrowings from Switzerland. Over the next few months,
ID: 2817917 • Letter: Y
Question
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.(using the information given, consider the relationship between them ) using the infromtion to explain and give the specific formula for every stepts.
Spot rate = 0.9888 CHF/USD
3 month forward rate = 3 month future rate = 0.9796 CHF/USD
Option Premia: Strike Price
Call Option
Put Option
0.9850
0.0108
0.0146
0.9900
0.0087
0.0175
Each option contract has a size of 125,000 Swiss Francs.
Option Premia: Strike Price
Call Option
Put Option
0.9850
0.0108
0.0146
0.9900
0.0087
0.0175
Explanation / Answer
Forward & Futures rate are the same.
As can be seen from Spot rate & Forward/Future rate, the dollar is depreciating against CHF and being a net payer it will magnify the losses.
Option A: Forward/Futures
Expected Cost: 50,000,000(0.9796-0.9888)= $4,60,000
Option B: Options
No of contracts= 50,000,000/125,000= 40 contracts
Since the dollar is depreciating we would buy put options with a strike price of 0.9900 to protect me from declining dollar rates.
Cost of put option= 40*0.0175= 0.70
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