Kansas Corp., an American company, has a payment of €5 million due to Tuscany Corp. one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $5,555,556, but Kansas faces the risk that the €/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strat- egies. Strategy 1 is to buy €5 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $100,000 for a one- year call option on €5 million at an exchange rate of 0.88 €/$.
Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas’s net dollar cost for the payable under each strategy?
Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas’s net dollar cost for the payable under each strategy?
Facts of the given case : Payment of €5 million after one year. Spot Price : 0.90 €/$
Strategy 1 | Buying Forward Contract |
Forward Price | 0.89 |
Amount Required in € | 50,00,000.00 |
Amount to be paid in $ | 56,17,977.53 |
Strategy 2 | Buying Option Contract |
1. Option Price | 0.88 |
2. Actual SPOT Price | 0.85 |
3. Amount Required in € | 50,00,000.00 |
4. Premium Amount in $ | 1,00,000.00 |
5. Amount to be paid in $ ( 1 Vs 2) | 56,81,818.18 |
Total Amount to be paid (4+5) In $ | 57,81,818.18 |
Strategy 1 | Buying Forward Contract |
Forward Price | 0.89 |
Amount Required in € | 50,00,000.00 |
Amount to be paid in $ | 56,17,977.53 |
Strategy 2 | Buying Option Contract |
1. Option Price | 0.88 |
2. Actual SPOT Price | 0.95 |
3. Amount Required in € | 50,00,000.00 |
4. Premium Amount in $ | 1,00,000.00 |
5. Amount to be paid in $ ( 1 Vs 2) | 52,63,157.89 |
Total Amount to be paid (4+5) In $ | 53,63,157.89 |
Kansas Corp., an American company, has a payment of €5 million due to Tuscany Corp. one...
PLEASE SHOW WORK BY HAND Kansas Corp., an American company, has a payment of €5 million due to Tuscany Corp. one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $5,555,556, but Kansas faces the risk that the €/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €5...
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