Question

1. Beaker, a US corporation, needs to pay S$ 1,000,000 after 90 days to its supplier in Singapore. Following quotes are current in the market: 2.00 percent 2.50 percent US$ 0.6333/S$ US$ 0.6375/S$ 90-day Singapore interest rate 90-day US interest rate Spot exchange rate 90-day forward exchange rate Calls and Put are available with exercise price = the forward rate Assume that the spot rate after 90 days can be US$ 0.6300/S$, US$ 0.6375/S$, or US$ 0.6450/S$ (i) Show the end-of-period cash flows in US$ for the possible future spot rates if Beaker stays unhedged. (ii If Beaker wanted to hedge this cash flow in the forward market, what contract would it need to enter into? Also, show the end-of-period cash flows in US$ for the possible future spot rates if Beaker enters into this forward market hedge (iii If Beaker wanted to hedge this cash flow in the options market, what would it need to do? Also, show the end-of-period cash flows in US$ for the possible future spot rates if Beaker enters into this option market hedge. (iv) If Beaker wanted to hedge this cash flow in the money market, what transactions would it need to enter into? Also, show the end-of-period cash flows in US$ for the possible future spot rates if Beaker enters into this money market hedge.

Answer 1

S$100000 equals to how many USD TODAY,

SPOT PRICE (US$) = 0.633333S$

100000S$= 100000*0.63333= 63330 US$

Spot Rate
1S$	0.6333	USD
Hence 1 $	1.579030475	SD

Forward Exchange Rate
1S$	0.6375	USD
1$	1.568627451	SD

i	If Beaker is unhedged
In the below calculations it is given hat, if the spot rates so and so, what would be the scenerio
Probable Spot rates		0.6300	0.6375	0.645
Payable In USD will be		63000	63750	64500
Initial Liability		63330	63330	63330
Net effect		330	-420	-1170
Cash out flow		63000	63750	64500
Note:	Due to unhedging, The US corporation is open to risk of any change in Exchange rates.
	So in case the Sing. $ becomes weak(i.e. favoring), it results in reduction of cash outflow,
	whereas in the adverse case, it results in the excess cash out flow.

ii	If Beaker is hedging the cash flow at forward rate i.e. USD 0.6375/S$
Probable Spot rates		0.6300	0.6375	0.645
Payable In USD will not change due to the Forward Contract		63750	63750	63750
Initial Liability		63330	63330	63330
The effective cash flow		-420	-420	-420
Total Inflow and out flow to US Corporation will be
Cash out flow		63750	63750	63750
Note : The forward exchange contract removes the risk of Exchange rate fluctuation, so the cash flow remains the same in any scenerio.
	Here the Commission is not given for the forward exchange contract, so it would be and extra cost in all three cases.

iii	If Beaker is planning to hedge the cash flow in Options market.
Option Strike price = Forward exchange Contract Price
i.e	0.6375/S$
So the Beaker will have to pay the option premium for exercising the Option.
Beaker will have to Buy Buy a Call option at a strike price of 0.6375/SD
So, in case the exchange rate is favoring the beaker, it will not exercise the option
So, in case the exchange rate is not favoring the beaker, it will exercise the option
Lets see how it will work
		Favoring	At par	Adverse
Probable Spot rates		0.6300	0.6375	0.645
Payable In USD		63000	63750	63750
Initial Liability		63330	63330	63330
The effective cash flow		330	-420	-420
Total Inflow and out flow to US Coproration will be
Cash out flow		63000	63750	63750
So, in this case US corporations risk out of excess cash outflow will be restricted to the strike price excersised