Cross-Hedging Strategy Assume that the country of Dreeland has a currency (called the dree) that tends to move in tandem with the Chilean peso and is expected to continue to move in tandem with the Chilean peso in the future. Indianapolis Co., a U.S. firm, has a large amount of receivables denominated in dree. It expects that the dree will depreciate against the dollar over time. No derivatives are available on the dree. Indianapolis Co. considers the following strategies to reduce its exchange rate risk: Use a money market hedge in which it converts dollars into dree and maintains a deposit denominated in dree for one year Use a forward contract to purchase Chilean pesos forward Sell a put option hedge on Chilean pesos Purchase a call option on Chilean pesos Use a forward contract in which it sells Chilean pesos forward Which strategy is most appropriate?

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 11, Problem 58QA
Textbook Problem

Cross-Hedging Strategy Assume that the country of Dreeland has a currency (called the dree) that tends to move in tandem with the Chilean peso and is expected to continue to move in tandem with the Chilean peso in the future. Indianapolis Co., a U.S. firm, has a large amount of receivables denominated in dree. It expects that the dree will depreciate against the dollar over time. No derivatives are available on the dree. Indianapolis Co. considers the following strategies to reduce its exchange rate risk:

  1. Use a money market hedge in which it converts dollars into dree and maintains a deposit denominated in dree for one year
  2. Use a forward contract to purchase Chilean pesos forward
  3. Sell a put option hedge on Chilean pesos
  4. Purchase a call option on Chilean pesos
  5. Use a forward contract in which it sells Chilean pesos forward Which strategy is most appropriate?

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