Union Corp must make a single payment of €5 million in six months at the maturity of a payable to a French firm. The finance manager expects the spot price of the € to remain stable at the current rate of $1.60/€. But as a precaution, the manager is concerned that the rate could rise as high as $1.70/€ or fall as low as $1.50/€. Because of this uncertainty, the manager recommends that Union Corp hedge the payment using either options or futures. Six months Call and Put options with an exercise price of $1.60/€ are available. The Call sells for $.08/€ and the Put sells for $.04/€. A six month futures contract on € is trading at $1.60/€. Should the manager be worried about the dollar depreciating or appreciating? If Union Corp decides to hedge using options, should it buy Calls or Puts to hedge the payment? Why? If futures are used to hedge, should the company buy or sell € futures? Why? What will be the net payment on the payable if an option contact was used? assume the following three scenarios: the spot price in six months will be $1.50/€, $1.60/€, or $1.70/€. What will be the net payment if futures had been used to hedge using the same scenarios as above? Which method of hedging is preferable?
Union Corp must make a single payment of €5 million in six months at the maturity of a payable to a French firm. The finance manager expects the spot price of the € to remain stable at the current rate of $1.60/€. But as a precaution, the manager is concerned that the rate could rise as high as $1.70/€ or fall as low as $1.50/€. Because of this uncertainty, the manager recommends that Union Corp hedge the payment using either options or futures. Six months Call and Put options with an exercise price of $1.60/€ are available. The Call sells for $.08/€ and the Put sells for $.04/€. A six month futures contract on € is trading at $1.60/€. Should the manager be worried about the dollar depreciating or appreciating? If Union Corp decides to hedge using options, should it buy Calls or Puts to hedge the payment? Why? If futures are used to hedge, should the company buy or sell € futures? Why? What will be the net payment on the payable if an option contact was used? assume the following three scenarios: the spot price in six months will be $1.50/€, $1.60/€, or $1.70/€. What will be the net payment if futures had been used to hedge using the same scenarios as above? Which method of hedging is preferable?
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
Problem 1PS
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Union Corp must make a single payment of €5 million in six months at the maturity of a payable to a French firm.
The finance manager expects the spot price of the € to remain stable at the current rate of $1.60/€.
But as a precaution, the manager is concerned that the rate could rise as high as $1.70/€ or fall as low as $1.50/€.
Because of this uncertainty, the manager recommends that Union Corp hedge the payment using either options or futures.
Six months Call and Put options with an exercise price of $1.60/€ are available.
The Call sells for $.08/€ and the Put sells for $.04/€.
A six month futures contract on € is trading at $1.60/€.
- Should the manager be worried about the dollar
depreciating or appreciating? - If Union Corp decides to hedge using options, should it buy Calls or Puts to hedge the payment? Why?
- If futures are used to hedge, should the company buy or sell € futures? Why?
- What will be the net payment on the payable if an option contact was used?
assume the following three scenarios: the spot price in six months will be $1.50/€, $1.60/€, or $1.70/€.
- What will be the net payment if futures had been used to hedge using the same scenarios as above?
- Which method of hedging is preferable?
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Step 1: Conceptual introduction to Hedging:
VIEWStep 2: 1. Should the manager be worried about the dollar depreciating or appreciating?
VIEWStep 3: 2. If Union Corp decides to hedge using options, should it buy Calls or Puts to hedge the payment?
VIEWStep 4: 3. If futures are used to hedge, should the company buy or sell € futures? Why?
VIEWStep 5: Net Payment with Options (3 Scenarios):
VIEWStep 6: Net Payment with Futures (3 Scenarios):
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