Question

Airbus sold an aircraft, A400, to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned with the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and six-month forward exchange rate is $1.10/€ at the moment. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six-month interest rate is 2.5% in the euro zone and 3.0% in the U.S.

1. Compute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using a forward contract.

b. If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case?

c. If Airbus decides to hedge using put options on U.S. dollars, what would be the ‘expected’ euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.

d. At what future spot exchange rate do you think Airbus will be indifferent between the option and money market hedge?

Answer 1

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Answer:

a. Airbus will sell $30 million forward for €27,272,727 = ($30,000,000)/ ($1.10/€). b. Airbus will borrow the present value of the dollar receivable, i.e., $29,126,214 = $30,000,000/1.03, and then sell the dollar proceeds spot for euros: €27,739,251. This is the euro amount that Airbus is going to keep. c. Since the expected future spot rate is less than the strike price of the put option, i.e., €0.9091< €0.95, Airbus expects to exercise the option and receive €28,500,000 = ($30,000,000)(€0.95/$). This is gross proceeds. Airbus spent €600,000 (=0.02x30,000,000) upfront for the option and its future cost is equal to €615,000 = €600,000 x 1.025. Thus the net euro proceeds from the American sale is €27,885,000, which is the difference between the gross proceeds and the option costs. d. At the indifferent future spot rate, the following will hold: €28,432,732 - ST(30.000.000) - €615,000. Solving for ST, we obtain the "indifference" future spot exchange rate, i.e., €0.9683/$, or $1.0327/€. Note that €28,432,732 is the future value of the proceeds under money market hedging: €28,432,732 = (€27,739,251) (1.025).