Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is 1.05 $/euro and the six-month forward rate exchange rate is 1.10 $/euro. Airbus can buy a six-month put option on U.S. dollars with a strike price of 0.95 euro/$ for a premium of .02 euro per U.S. dollar. Currently, the six-month interest rate is 2.5% in the euro zone and 3% in the United States. Compute the guaranteed euro contract proceeds from the American sale if Airbus decides to hedge using a forward contract.If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case?If Airbus decides to hedge using put options on U.S. dollars, what would be the “expected” euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot rate.At what future spot exchange rate do you think Airbus will be indifferent between the option and money market hedge?

Answered: Airbus sold an A400 aircraft to Delta…

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter18: Long-term Debt Financing

Section: Chapter Questions

Problem 15QA

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Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is 1.05 $/euro and the six-month forward rate exchange rate is 1.10 $/euro. Airbus can buy a six-month put option on U.S. dollars with a strike price of 0.95 euro/$ for a premium of .02 euro per U.S. dollar. Currently, the six-month interest rate is 2.5% in the euro zone and 3% in the United States.

Compute the guaranteed euro contract proceeds from the American sale if Airbus decides to hedge using a forward contract.
If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case?
If Airbus decides to hedge using put options on U.S. dollars, what would be the “expected” euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot rate.
At what future spot exchange rate do you think Airbus will be indifferent between the option and money market hedge?

Definition Definition Financial market that deals in securities or assets that are short-term in nature. The money market is responsible for keeping up the liquidity of the businesses and the organizations. These securities are usually held for a period of 12 months or less and are issued by institutions that require cash or funds for their short-term cash flow requirements. The money market is regulated by the federal government.

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The forward exchange rate is the future rate at which a bank agrees to exchange the currency of one country for another country's currency at a future date prespecified when it enters into an agreement.

The currency market contains the risk of adverse price movements that may cause a million dollar loss to an investor. Therefore, many investors hedge their investment risks by using strategic decisions.

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