Question

Norton Corp. sold a computer system to a customer in the UK and billed £20 million receivable in one year. Norton would like to control for the exchange rate risk. The current spot exchange rate is $1.30/£ and one-year forward exchange rate is $1.27/£ at the moment. Norton can buy a one-year put option on £20 million with a strike price of $1.32/£ for a premium of $0.02 per pound. It can also buy a one-year call option on £20 million with a strike price of $1.29/£ for a premium of $0.15 per pound. Currently, one-year interest rate is 6.1% in the U.K. and 5.0% in the U.S.

1.Compute the guaranteed dollar proceeds from the sale if Norton decides to hedge using a forward contract.

2.If Norton decides to hedge using money market instruments, what action does Norton need to take? What would be the guaranteed dollar proceeds from the sale in this case?

3.If Norton decides to hedge using options on pounds, what option (put or call) will Norton use? And what would be the ‘expected’ dollar proceeds from the aircraft sale? Assume that Norton regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.

4.Based on the available information and your calculations above, what is your recommendation to Norton for a best strategy (forward hedge vs money market hedge vs options hedge)? Why?Other things being equal, at what forward rate would Norton be indifferent between the forward and money market hedge?

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

File Home Insert Page Layout Formulas Data Review View Add-Ins Cut Ea Copy - AutoSum A A Wrap Text Calibri 11 General Fill A Merge & Center Conditional Format Formatting Insert Delete Format Paste S % Cell Sort & Find & BIU 2 Clear Format Painter er Select ble Styles Clipboard Font Alignment Number Shules Cells Editing IP226 | IK IL IM IN JO IP 208 209 FORWARD HEDGE a 210 GUARANTEED DOLLAR PROCEEDS FROM SALE USING FORWARD HEDGE 211 FORWARD RATE X AMOUNT RECEIVABLE 25400000 [1.27 X 20000000] 212 213 MONEY MARKET HEDGE 214 AS WE ARE HAVING RECEIVABLES 18850141.38 20000000/(1+0.06 1)] 215 WE NEED TO BORROW POUND TODAY = AMOUNT RECEIVABLE/ (1+ UK RATE) 216 217 CONVERT POUND IN $ AT SPOT RATE 218 219 DOLLAR RECEIVABLE 24505183.79 [18850141.38 X 1.30] 220 AMOUNT IN POUNDS TODAY X SPOT RATE 221 25730442.98 [24505183.79 X (1+0.05)] 222 INVEST DOLLAR AT 5% RATE IN US 223 GUARANTEED DOLLAR PROCEEDS = 25730442.98 224 225 OPTIONS HEGDE C 226 AS WE ARE HAVING RECEIVABLES PV, FV, ANNUITYDIR rightclean UTILITY, SHARPE, beta bond covexity DGM RESI ex d port future INDEX INTL CAP BUD YIELD bond portfolo cap stru WACC 130 % KE CAPM LEASING Re erences: 130 W 09:06 ENG 5-06-2019

File Home Insert Page Layout Formulas Data Review View Add-Ins - Cut AutoSum A A Wrap Text Calibri 11 General Fill Copy BI U A- Merge & Center Conditional Format Insert Delete Format Paste Cell Sort & Find & 2 Clear Format Painter er Select Formatting ble Styles Clipboard Font Alignment Number Shules Cells Editing IP243 IM IK IL IN IP 225 OPTIONS HEGDE C 226 AS WE ARE HAVING RECEIVABLES 227 WE HAVE TO GO FOR PUT OPTION 228 400000 [-20000000*0.02] 229 PREMIUM PAYABLE = 230 AMOUNT RECEIVABLE X PREMIUM 231 232 NOW IF THE PRICE IS BELOW STRIKE PRICE= 1.32, WE WILL EXERCISE OPTIONS 233 OTHERWISE NOT SO IN ANY CASE, MINIMUM GUARANTEED DOLLAR RECEIVABLE 234 GUARANTEED DOLLAR PROCEEDS - 26000000 [20000000*1.32- 400000] 235 236 d 237 FROM THE ABOVE CALCULATIONS, 238 OPTIONS HEDGE IS THE BEST AS IT HAS HIGHEST DOLLAR RECEIVABLE 239 240 RATE THAT MAKES FORWARD HEDGE AND MONEY MARKET HEDGE INDIFFERENT FORWARD RATE X AMOUNT RECEIVABLE = AMOUNT RECEIVABLE MONEY MARKET HEDGE 241 242 FORWARD RATE X 20000000 25730442.98 243 FORWARD RATE = 1.29 port future INDEX DIR right UTILITY, SHARPE, beta erences: 130 bond covexty DGM PV, FV, ANNUITY RESI ex d YIELD bond portfolo cap stru WACC 130 % KE CAPM INTL CAP BUD LEASING clean Re W 09:06 ENG 5-06-2019