Question

Techniques for Hedging Receivables. SMU Corp. has future receivables of 4,000,000 New Zealand dollars (NZ$) in one year. It must decide whether to use options or a money market hedge to hedge this position. Use any of the following information to make the decision. Verify your answer by determining the estimate (or probability distribution) of dollar revenue to be received in one year for each type of hedge.

      Spot rate of NZ$ = $.54

      One‑year call option: Exercise price = $.50; premium = $.07

      One‑year put option: Exercise price = $.52; premium = $.03

                                                                                    U.S.     New Zealand

            One‑year deposit rate                                        9%           6%

            One‑year borrowing rate                                    11             8

                                                                                    Rate    Probability

            Forecasted spot rate of NZ$                                $.50           20%

                                                                                       .51           50

                                                                                       .53        30

Answer 1

	Put option hedge (Exercise price = $.52; premium = $.03)
	Possible Spot Rate	Put Option Premium	Exercise Option	Amount per Unit Received Accounting for Premium	Total Amount Received for NZ$4,000,000	Probability
	$0.50	$0.03	Yes	$0.49	$1,960,000	20%
	$0.51	$0.03	Yes	$0.49	$1,960,000	50%
	$0.53	$0.03	No	$0.50	$2,000,000	30%
	Money market hedge
1	Borrow NZ$3,703,704 (NZ$4,000,000/1.08 = NZ$3,703,704)
2	Convert NZ$3,703,704 to $2,000,000 (at $.54 per New Zealand dollar)
3	Invest $2,000,000 to accumulate $2,180,000 at the end of one year ($2,000,000 × 1.09 = $2,180,000)
	The money market hedge is superior to the put option hedg