Question

Boeing just signed a contract to sell a Boeing 737 aircraft to British Airways and will receive £60 million in six months. The current spot exchange rate is $1.3800/£ and the six-month forward rate is $1.4000/£. Boeing can buy a six-month put option on the British pound with an exercise price of $1.3500/£ for a premium of $0.020/£. Currently, the six-month interest rate is 1.880 percent per annum in the United States and 0.700 percent per annum in the UK. Boeing believes that the British pound would likely appreciate from its current level, but would still like to hedge its foreign exchange exposure.

1. Explain how Boeing should do a forward hedge. Compute the guaranteed dollar proceeds from the British Airway sales if Boeing decides to hedge using a forward contract.

2. If Boeing decides to hedge using put options on the British pound, what would be the “expected” net dollar proceeds from the British Airway sale? Assume that Boeing regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.

3. At what future spot exchange rate do you think Boeing will be indifferent between the option hedge and forward hedge?

4. Graph your answers with the proper post-hedging net $ proceed charts, labeling your foreign exchange rates and net proceeds properly.