Question

(2)(a) Suppose that Loras corporation needs 100,000 euros 180 days from now. It is trying to determine whether or not to hedge this position. It developed the following probability distribution for the euro: Possible value of the pound in 180 days: $1.40 1.45 1.48 1.50 1.53 1.55 Probability: The 180-day forward rate for the pound is S1.52 The spot rate for the pound is S1.49. Given the available information determine the expected value of the real cost of hedging and comment on the desirability or otherwise of hedging the payables. 5% 10 30 30 20 5 (b) A Factor agrees to buy an exporter's receivables at a 4.5% per month discount. In addition, the Factor charges a 2.25 % fee for non-recourse financing. If the exporter decides to factor $5million in 90-day receivables, how much will the exporter receive? If the financing is with recourse, will the amount received by the exporter be different? Explain with quantitative evidence.

Answer 1

Answer: a) Expected value of Pound at the end ofyear 1.4X.05+1.45X.10+1.48X3+1.5X3+1.53X.20+1.55X05 -$1.49 180days forward rate $1.52 Spotrate $1.49 Cost of hedging using forward rate (1.52-1.49) X100000 - $3000 Comment: It is better to wait without hedging because expected 180days future rate is less than forward rate which is $1.49 b) Total value of receivable $5000000 Discount (5000000) X4-5903-$675 000 Non recourse fees (5000000-675000) X2.25%-$973 12.5 Balan ce amount exporter will received (5000000-675000-97312.5) -$4227687.5 In case it is recourse financing than exporter will not pay Non recourse fees which is $97312.5