Concept explainers
You are a broker for frozen seafood products for Choyce Products. You just signed a deal with a Belgian distributor. Under the terms of the contract, in one year you will deliver 4000 kilograms of frozen king crab for 100,000 euros. Your cost for obtaining the king crab is $110,000.All cash flows occur in exactly one year.
a. Plot your profits In one year from the contract as a function of the exchange rate in one year, for exchange rates from $0.75/€ to $1.50/€. Label this line “Unhedged Profits.”
b. Suppose the one-year forward exchange rate is $1.25/€, and that you enter into a forward contract to sell the euros you will receive at this rate. In the figure from (a), plot your combined profits from the crab contract and the forward contract as a function of the exchange rate in one year. Label this line “Forward Hedge.”
c. Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy euros at a strike price of $1.25/€ is trading for $0.10/€. Similarly, a one-year put option to sell euros at a strike price of $1.25/€ is trading for $0.10/€. To hedge the risk of your profits, should you buy or sell the call or the put?
d. In the figure from (a) and (b), plot your “all in” profits using the option hedge (combined profits of crab contract, option contract, and option price) as a function of the exchange rate in one year. Label this line “Option Hedge.” (Note: You can ignore the effect of interest cii the option price.)
e. Suppose that by the end of the year, a trade war erupts, leading to a European embargo on U.S. food products. As a result, your deal is cancelled, and you don’t receive the euros or incur the costs of procuring the crab. However, you still have the
Want to see the full answer?
Check out a sample textbook solutionChapter 23 Solutions
Fundamentals of Corporate Finance, Student Value Edition (3rd Edition) - Standalone book
- Boisjoly Watch Imports has agreed to purchase 15,000 Swiss watches for 1 million francs at today’s spot rate. The firm’s financial manager, James Desreumaux, has noted the following current spot and forward rates: On the same day, Desreumaux agrees to purchase 15,000 more watches in 3 months at the same price of 1 million Swiss francs. What is the cost of the watches in U.S. dollars, if purchased at today’s spot rate? What is the cost in dollars of the second 15,000 batch if payment is made in 90 days and the spot rate at that time equals today’s 90-day forward rate? If the exchange rate for is 0.50 Swiss francs per dollar in 90 days, how much will Desreumaux have to pay (in dollars) for the watches?arrow_forwardFrench car maker Renault signed a $95 million contract with ABB of Zurich, Switzerland, for automated underbody assembly lines, body assembly workshops, and line control systems. If ABB will be paid in 3 years, when the systems are ready, what is the present worth of the contract at 12% per year interest?arrow_forwardA store manager plans to exchange his old computer at the end of four years for a newer one worth P150,000. The trade in value of the old computer at that time is estimated to be P4,000. If money can be invested at 12% compounded quarterly, how much must the manager invest at the end of each quarter in order to make the exchange?arrow_forward
- Kristo Asafo Tools Ltd is filling an order from a Korean industrial company for machinery worth 160,000,000 Won. The export sale is denominated in Korean Won and is on a one-year open account basis. The opportunity cost of funds for Kristo Asafo Tools Ltd is 8% The Current spot rate between Won and Dollars is 800 Won/$. The forward Won sells at a discount of 12% per annum, but the finance staff of Kristo Asafo Tools Believes that the Won will drop only 9% in value over the next year. Kristo Asafo Tools Ltd faces the following choices This question compares the cost of a money market hedge with a forward hedge, and considers both alternatives against the possibility of remaining unhedged. a) Wait one year to receive the won amount and exchange Won for dollars at that time b) Sell the Won proceeds of the sale forward today c) Borrow Won from a Seoul bond at 20% per annum against the expected future receipt of the Korean importer’s payment d) What do you recommend and why?arrow_forwardYour factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flows from the contract would be $5.07 million per year. Your upfront setup costs to be ready to produce the part would be $8.02 million. Your discount rate for this contract is 7.8%. a. What does the NPV rule say you should do? b. If you take the contract, what will be the change in the value of your firm? (Round to two decimal places.)arrow_forwardWhile you were visiting London, you purchased a Jaguar for £35,000, payable in three months. You have enough cash at your bank in New York City, which pays 0.22% interest per month, compounding monthly, to pay for the car. Currently, the GBP/USD is 1.4580 and the three-month forward is 1.4255. In London, the money market interest rate is 2.5% for a three-month investment. You are studying the following payment method (a) Keep the funds at your bank in the U.S. and buy £35,000 forward. How much would it cost you in USD? (no cents)arrow_forward
- Agyenim Boateng, owner of the Best Pineapple Company Ltd will be receiving 20,000 British pounds about one month from now as payment for pineapple juice produced and exported by his company. Agyenim is concerned about his exposure because he believes that there are two possible scenarios: (1) the pound will depreciate by 3 percent over the next month or (2) the pound will appreciate by 2 percent over the next month. There is a 70 percent chance that Scenario 1 will occur. There is a 30 percent chance that Scenario 2 will occur. Agyenim notices that the prevailing spot rate of the pound is GHS 8.1 and the onemonth forward rate is GHS 8.6. Agyenim can purchase a put option over the counter from a securities firm that has an exercise (strike) price of GHS 8.6, a premium of GHS0.025, and an expiration date of one month from now. Determine the amount of cedis received by the Best Pineapple Company under each of the two exchange rate scenarios if: a) The receivables to be received in one…arrow_forwardYour factory has been offered a contract to produce a part for a new printer. The contract would last for three years, and your cash flows from the contract would be $4.94 million per year. Your upfront setup costs to be ready to produce the part would be $7.97 million. Your discount rate for this contract is 8.1%. What is the IRR? The IRR is ____% (Round to two decimal places)arrow_forwardMoonlight Industries just signed a sales contract with a new customer. JK will receive annual payments in the amount of $50,000, $96,000, $123,000, and $138,000 at the end of Years 1 to 4, respectively. What is this contract worth at the end of Year 4 if the firm earns 3.75 percent on its savings? Can the excel and calculator solution be provided?arrow_forward
- A customer wants to buy a house with a cash value of 1,000,000 riyals, and the customer will pay 40% of the house’s price in cash, and the bank will finance 60% of the house’s value. If the customer wants to pay the rest of the amount in installments over a period of ten years at a profit rate of 7.5% annually, then the total value of the house will be That the customer pays 1.75 million riyals (true or false)??arrow_forwardWeston Corporation, a US multinational, is considering building a new assembly plant in Thailand at a total cost of 300 million Baht to be financed with 50% debt and 50% equity. Managers plan to raise half of the new debt with the sale of bonds in the US paying 8% interest annually and principal repayment in five years. The other half of the new debt will come from the sale of bonds in Thailand paying 10% interest annually and principal repayment in five years. The current spot rate is 30 Baht/USD and the Baht is expected to appreciate against the dollar by 2% per year over the next five years. Weston’s marginal income tax rate is 30% in both the US and Thailand. 1. Excluding floatation costs, what is Weston’s after-tax cost of debt for the project? 2. Assume Weston raises equity finance with the sale of shares in Thailand. If the average 90-day Thai T-bill rate is 5%, the average return on the Thai market index is 14% and Weston’s equity beta is 1.5, what is Weston’s cost of equity…arrow_forwardFergusson Corporation, a U.S. company, manufactures components for the automobile industry. In the past, Fergusson purchased actuators used in its products from a supplier in the United States. The company plans to shift its purchases to a supplier in Portugal. Fergusson's CFO expects to place an order with the Portuguese supplier in the amount of 200,000 euros in three months. In contemplation of this future import, the CFO purchased a euro call option to hedge the cash flow risk that the euro appreciate against the U.S. dollar over the next three months. The CFO is aware that a foreign currency option used to hedge the cash flow risk associated with a forecasted foreign currency transaction may be designated as a hedge for accounting purposes only if the forecasted transaction is probable. However, he is unsure how he should demonstrate that the anticipated import purchase from Portugal is likely to occur. He wonders whether management's intention to make the purchase is…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning