Larkin Hydraulics. On May 1, Larkin Hydraulics, a wholly owned subsidiary of Caterpillar (U.S.), sold a 12-megawatt compression turbine to Rebecke-Terwilleger Company of the Netherlands for €4,800,000, payable as £2,400,000 on August 1 and £2,400,000 on November 1. Larkin derived its price quote of €4,800,000 on April 1 by dividing its normal U.S. dollar sales price of $5,136,000 the then current spot rate of $1.0700/€. By the time the order was received and booked on May 1, the euro had strengthened to $1.1200/€, so the sale was in fact worth €4,800,000x$1.1200/€ = $5,376,000. Larkin had already gained a extra $240,000 from favorable exchange rate movements. Nevertheless, Larkin's director of finance now wondered if the firm should hedge against a reversal of the recent trend of the euro. Four approaches were possible: a. Hedge in the forward market: The 3-month forward exchange quote was $1.1280/€ and the 6-month forward quote was $1.1360/€. b. Hedge in the money market: Larkin could borrow euros from the Frankfurt branch of its U.S. bank at 9.69% per annum. c. Hedge with foreign currency options: August put options were available at strike price of $1.1200/€ for a premium of 1.8% per contract, and November put options were available at $1.1200/€ for premium of 1.3%. August call options at $1.1200/€ could be purchased for a premium of 2.8%, and November call options at $1.1200/€ were available at a 2.7% premium. d. Do nothing: Larkin could wait until the sales proceeds were received in August and November, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in the spot market. -C a. How much in U.S. dollars will Larkin receive on November 1st with a forward market hedge?
Larkin Hydraulics. On May 1, Larkin Hydraulics, a wholly owned subsidiary of Caterpillar (U.S.), sold a 12-megawatt compression turbine to Rebecke-Terwilleger Company of the Netherlands for €4,800,000, payable as £2,400,000 on August 1 and £2,400,000 on November 1. Larkin derived its price quote of €4,800,000 on April 1 by dividing its normal U.S. dollar sales price of $5,136,000 the then current spot rate of $1.0700/€. By the time the order was received and booked on May 1, the euro had strengthened to $1.1200/€, so the sale was in fact worth €4,800,000x$1.1200/€ = $5,376,000. Larkin had already gained a extra $240,000 from favorable exchange rate movements. Nevertheless, Larkin's director of finance now wondered if the firm should hedge against a reversal of the recent trend of the euro. Four approaches were possible: a. Hedge in the forward market: The 3-month forward exchange quote was $1.1280/€ and the 6-month forward quote was $1.1360/€. b. Hedge in the money market: Larkin could borrow euros from the Frankfurt branch of its U.S. bank at 9.69% per annum. c. Hedge with foreign currency options: August put options were available at strike price of $1.1200/€ for a premium of 1.8% per contract, and November put options were available at $1.1200/€ for premium of 1.3%. August call options at $1.1200/€ could be purchased for a premium of 2.8%, and November call options at $1.1200/€ were available at a 2.7% premium. d. Do nothing: Larkin could wait until the sales proceeds were received in August and November, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in the spot market. -C a. How much in U.S. dollars will Larkin receive on November 1st with a forward market hedge?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Transcribed Image Text:Larkin Hydraulics. On May 1, Larkin Hydraulics, a wholly owned subsidiary of Caterpillar (U.S.), sold a 12-megawatt compression turbine to Rebecke-Terwilleger Company of the Netherlands for
€4,800,000, payable as €2,400,000 on August 1 and €2,400,000 on November 1. Larkin derived its price quote of €4,800,000 on April 1 by dividing its normal U.S. dollar sales price of $5,136,000 by
the then current spot rate of $1.0700/€.
By the time the order was received and booked on May 1, the euro had strengthened to $1.1200/€, so the sale was in fact worth €4,800,000 x $1.1200/€ = $5,376,000. Larkin had already gained an
extra $240,000 from favorable exchange rate movements. Nevertheless, Larkin's director of finance now wondered if the firm should hedge against a reversal of the recent trend of the euro. Four
approaches were possible:
a. Hedge in the forward market: The 3-month forward exchange quote was $1.1280/€ and the 6-month forward quote was $1.1360/€.
b. Hedge in the money market: Larkin could borrow euros from the Frankfurt branch of its U.S. bank at 9.69% per annum.
c. Hedge with foreign currency options: August put options were available at strike price of $1.1200/€ for a premium of 1.8% per contract, and November put options were available at $1.1200/€ for
premium of 1.3%. August call options at $1.1200/€ could be purchased for a premium of 2.8%, and November call options at $1.1200/€ were available at a 2.7% premium.
d. Do nothing: Larkin could wait until the sales proceeds were received in August and November, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in
the spot market.
C
a. How much in U.S. dollars will Larkin receive on November 1st with a forward market hedge?
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