Economics Homework Help

Comparison of Techniques for Hedging Receivables.

Assume that Carbondale Co. expects to receive S$500,000 in one year.  The existing spot rate of the Singapore dollar is $.60.  The one?year forward rate of the Singapore dollar is $.62.  Carbondale created a probability distribution for the future spot rate in one year as follows:

Future Spot Rate Probability

                               $.58                                                         20%

                                 .63                                                         50

                                 .67                                                         30

           Assume that one?year put options on Singapore dollars are available, with an exercise price of $.63 and a premium of $.04 per unit. One?year call options on Singapore dollars are available with an exercise price of $.60 and a premium of $.03 per unit.  Assume the following money market rates:

U.S. Singapore

                 Deposit rate                         7%                         4%

                 Borrowing rate                    8                           5

           Given this information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate.  Then compare the most appropriate hedge to an unhedged strategy, and decide whether Carbondale should hedge its receivables position.

     ANSWER:

Forward hedge

Money market hedge

 Option hedge

Possible Spot Rate

Option Premium per Unit

Exercise

Yes or

No?

Amount Received per Unit (also accounting for premium)

Total Amount Received for S$500,000

Probability

Unhedged Strategy

Possible Spot Rate

Total Amount Received for S$500,000

Probability

1. Assume that Baton Rouge, Inc. expects to need S$1 million in one year.  Using any relevant information in part (a) of this question, determine whether a forward hedge, a money market hedge, or a currency options hedge would be most appropriate.  Then, compare the most appropriate hedge to an unhedged strategy, and decide whether Baton Rouge should hedge its payables position.

     ANSWER:

Forward hedge

Money market hedge

Option hedge

Amount Paid                Total

     Option                                                       per Unit                 Amount

     Possible       Premium      Exercise           (including                Paid for               

Spot Rate per Unit Option? the premium) S$1,000,000 Probability

Unhedged Strategy

           Possible                                                 Total

Spot Rate                                       Amount Paid                   Probability