Question

Assume you are the CFO of AIFS. Your analyst reports the following information (Use the following information for the remainder of the assignment):

• Current exchange rate is $1.16/€.

• Forward rate is $1.185/€.

• Expected final sales volume is 30,000. Worst case scenario is volume of 10,000. Best

  case scenario is volume of 36,000.

• Cost per student is €2500.

• Option premium is 2% of USD strike price.

• Option strike price is $1.165/€.

  4. Using the above information

  a) What is the total projected costs (for all three scenarios) in dollars at the current exchange rate?

  b) What are the total costs (for all three scenarios) if you use a forward contract to hedge? c) What is the total option premium for each scenario?

  5. As the CFO, you decided not to hedge. Assuming expected final sales volume is 30,000, what are your total costs

  a) if the exchange rate remains at $1.16/€? Let’s call this the baseline scenario.
  b) if the exchange rate will be $1.25/€? How does this compare to the baseline case? c) if the exchange rate will be $1.08/€? How does this compare to the baseline case?

  6. As the CFO, you decided to hedge using forward contracts. Assume that the expected final sales volume is 30,000. What are your total benefit/cost and the percentage benefit/cost from hedging (compared to no hedging)

  a) if the exchange rate remains at $1.16/€? b) if the exchange rate will be $1.25/€?
  c) if the exchange rate will be $1.08/€?

Dr. Ruchith Dissanayake School of Economics and Finance Semester 1, 2019 QUT Business School | QUT

7. As the CFO, you decided to hedge using option contracts. Assuming expected final sales volume is 30,000, what are your total benefit/cost and the percentage benefit/cost from hedging (compared to no hedging)

a) if the exchange rate remains at $1.16/€? b) if the exchange rate will be $1.25/€?
c) if the exchange rate will be $1.08/€?

8. What is the most profitable strategy for the case in which the expected final sales volume is 30,000 (no hedge, forward contract, or option contract)

a) if the exchange rate remains at $1.16/€? b) if the exchange rate will be $1.25/€?
c) if the exchange rate will be $1.08/€?
d) Is there a best strategy? Why?

COMPLETE SOULUTIONS PLEASE

Answer 1

4] a]

At the current exchange rate,

cost for 30,000 volume = 30,000 * $1.16 * 2,500 = $87,000,000

cost for 10,000 volume = 10,000 * $1.16 * 2,500 = $29,000,000

cost for 36,000 volume = 36,000 * $1.16 * 2,500 = $104,400,000

4] b]

cost for 30,000 volume = 30,000 * $1.185 * 2,500 = $88,875,000

cost for 10,000 volume = 10,000 * $1.185 * 2,500 = $29,625,000

cost for 36,000 volume = 36,000 * $1.185 * 2,500 = $106,650,000

4] c]

option premium for 30,000 volume = 30,000 * $1.165 * 2%* 2,500 = $1,747,500

option premium for 10,000 volume = 10,000 * $1.165 * 2%* 2,500 = $582,500

option premium for 36,000 volume = 36,000 * $1.165 * 2%* 2,500 = $2,097,000

5] a]

total cost = 30,000 * 1.16 * 2,500 = $87,000,000