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.
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
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.
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