A U.K importer has future payables of DM 20,000,000 in one year. The importer must decide whether to use option or a money market to hedge this position. The following information is available Spot rate £ 0.74 =DM1 One year call option Exercise Price £ 0.76= DM1 Premium £ 0.04 per DM One year Put Option Exercise Price £ 0.77 =DM Premium £ 0.02 per DM Sterling Deposit Rate 8% Per Annum Sterling Borrowing Rate 9% Per Annum DM Deposit Rate 6% Per Annum DM Borrowing Rate 7% Per Annum Forecast one-spot Rate £ 0.70 £0.77 £0.70 Probability 25% 55% 20% Required: Assume that the importer’s objective is to minimize the sterling value of DM payables. Which of the hedging instruments would you recommend? Verify your answer by estimating the sterling cost for each type of hedge. Compare cost of hedging and non-hedging
A U.K importer has future payables of DM 20,000,000 in one year. The importer must
decide whether to use option or a
information is available
Spot rate £ 0.74 =DM1
One year call option
Exercise Price £ 0.76= DM1
Premium £ 0.04 per DM
One year Put Option
Exercise Price £ 0.77 =DM
Premium £ 0.02 per DM
Sterling Deposit Rate 8% Per Annum
Sterling Borrowing Rate 9% Per Annum
DM Deposit Rate 6% Per Annum
DM Borrowing Rate 7% Per Annum
Probability 25% 55% 20%
Required:
Assume that the importer’s objective is to minimize the sterling value of DM payables.
Which of the hedging instruments would you recommend? Verify your answer by estimating
the sterling cost for each type of hedge. Compare cost of hedging and non-hedging
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