Incantieri sold a cruise ship to Disney Cruise Line, a U.S. company, and billed $1 billion payable in six months. It is concerned with the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.15/€ and six-month forward exchange rate is $1.21/€ at the moment. Incantieri can buy a six-month put option on U.S. dollars with a strike price of €0.85/$ for a premium of €0.02 per U.S. dollars. Currently, the six-month interest rate is 2% in the euro zone and 2.5% in the U.S. 1. Compute the guaranteed euro proceeds from the American sale if Incantieri decides to hedge using a forward contract. 2. If Incantieri decides to hedge using money market instruments, what action does Incantieri need to take? What would be the guaranteed euro proceeds from the American sale in this case? 3. If Incantieri decides to hedge using put options on U.S. dollars, what would be the ‘expected’ euro proceeds from the American sale? Assume that Incantieri regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate. 4. Which method of hedging would you recommend to Incantieri in order to control the exchange risk? Think about its pros and cons.

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter11: Managing Transaction Exposure

Section: Chapter Questions

Problem 26QA

See similar textbooks

Related questions

Concept explainers

Question

Incantieri sold a cruise ship to Disney Cruise Line, a U.S. company, and billed $1 billion payable in six months. It is concerned with the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.15/€ and six-month forward exchange rate is $1.21/€ at the moment. Incantieri can buy a six-month put option on U.S. dollars with a strike price of €0.85/$ for a premium of €0.02 per U.S. dollars. Currently, the six-month interest rate is 2% in the euro zone and 2.5% in the U.S.

1. Compute the guaranteed euro proceeds from the American sale if Incantieri decides to hedge using a forward contract.
2. If Incantieri decides to hedge using money market instruments, what action does Incantieri need to take? What would be the guaranteed euro proceeds from the American sale in this case?
3. If Incantieri decides to hedge using put options on U.S. dollars, what would be the ‘expected’ euro proceeds from the American sale? Assume that Incantieri regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.
4. Which method of hedging would you recommend to Incantieri in order to control the exchange risk? Think about its pros and cons.

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.

Expert Solution

Trending now

This is a popular solution!

Step by step

Solved in 4 steps

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.