Chapter 8 Problems Essay

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Chapter 8 1,4,5 1. Cray Research sold a super computer to the Max Planck Institute in Germany on credit and invoiced €10 million payable in six months. Currently, the six-month forward exchange rate is $1.10/€ and the foreign exchange advisor for Cray Research predicts that the spot rate is likely to be $1.05/€ in six months. (a) What is the expected gain/loss from the forward hedging? The expected gain from this sale can be figured by using this equation: 10,000,000(1.10-1.05)=10,000,000(.05)=$500,000 expected gain (b) If you were the financial manager of Cray Research, would you recommend hedging his euro receivable? Why or why not? Cray Research should hedge in this situation. Hedging will…show more content…
This amount can be invested at the dollar interest rate for one year which will yield $21,200,000. Using the forward hedging method, the firm will receive $800,000 more. (b) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods? IRP says that F = S(1+i$)/(1+iF) so this shows that the “indifferent” forward rate will be: F = 1.05(1.06)/1.05 = $1.06/€. 5. Suppose that Baltimore Machinery sold a drilling machine to a Swiss firm and gave the Swiss client a choice of paying either $10,000 or SF 15,000 in three months. (a) In the above example, Baltimore Machinery effectively gave the Swiss client a free option to buy up to $10,000 dollars using Swiss franc. What is the ‘implied’ exercise exchange rate? The implied exercise exchange rate is $0.6667/SF. (10,00/15,000) (b) If the spot exchange rate turns out to be $0.62/SF, which currency do you think the Swiss client will choose to use for payment? What is the value of this free option for the Swiss client? I think the Swiss client should choose the option to pay the SF15,000 because with the spot exchange rate upping to $0.62, that would make the equivalent of $10,000 up to SF16,129. This is figured like this: 10,000/.62. (c) What is the best way for Baltimore Machinery to deal with the exchange exposure?

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