Scenario: You are an American Red Cross Disaster Program Specialist in charge of teams trained to help in sheltering displaced p
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Answer:
Explanation:
a)
In the case of forwarding hedge:
The future dollar cost will be = FX receiveable ÷ Foward exchange rate
= 500 million yen ÷ 110 yen/dollar
= $4.55 million
For money market hedge:
Present value of yen payable =
= 476.20 million yen
PCC would convert dollars to yens at the spot market rate and borrow yen such that it would get 500 million yen at maturity(i.e after one year) for Mitsubishi to receive it.
Dollars needed to get these yen = 476.30 yen ÷ 124 yen/dollar
= $3.84 million
Future Value of these dollars (for comparison with the foward market hedge) = $3.84 × (1 + 0.08)
= $4.15 million
Hence, the money market hedge is better as the dollar cost is lower than the forward market hedge to meet the obligation.
b)
On the maturity date, the spot rate is 110 yen/dollar
Ad the strike price = 0.0081 /dollar
It is better for the company to go for the strike price due to the fact that it has a lower rate than the spot rate.
Now;
The premium amount = 500000000 yen × 0.014 dollar / yen
= 70000 dollars
However; the Future dollar-cost payable = 500000000 yen × 0.0081 dollar /yen
= 4050000 dollars
By applying option hedge, the total dollar cost required to meet the obligation = (4050000 + 70000) dollars
= 4120000 dollars
c)
The dollar cost needed from the option hedge required to matching the forward hedge is determined by subtracting it from the premium amount:
Thus;
for option hedge, dollar cost needed = (4550000 - 70000) dollars
= 4480000 dollars
The required future spot rate = 500000000/4480000
= 111.61 yen/dollar
As a result, at the future spot rate of 111.61 yen/dollar, PCC will be unconcerned about and indifferent about the option or forward hedge because the future dollar cost of meeting the obligation will be the same.