Howard University Comparison
Comparison of Techniques for Hedging Receivables.
Assume that Carbondale Co. expects to receive S$500,000 in one year. The existing spot rate of the Singapore dollar is $.60. The one‑year forward rate of the Singapore dollar is $.62. Carbondale created a probability distribution for the future spot rate in one year as follows:
Future Spot Rate Probability
$.58 20%
.63 50
.67 30
Assume that one‑year put options on Singapore dollars are available, with an exercise price of $.63 and a premium of $.04 per unit. One‑year call options on Singapore dollars are available with an exercise price of $.60 and a premium of $.03 per unit. Assume the following money market rates:
U.S. Singapore
Deposit rate 7% 4%
Borrowing rate 8 5
Given this information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate. Then compare the most appropriate hedge to an unhedged strategy, and decide whether Carbondale should hedge its receivables position.
ANSWER:
Forward hedge
Money market hedge
Option hedge
Possible Spot Rate |
Option Premium per Unit |
Exercise Yes or No? |
Amount Received per Unit (also accounting for premium) |
Total Amount Received for S$500,000 |
Probability |
Unhedged Strategy
Possible Spot Rate |
Total Amount Received for S$500,000 |
Probability |
- Assume that Baton Rouge, Inc. expects to need S$1 million in one year. Using any relevant information in part (a) of this question, determine whether a forward hedge, a money market hedge, or a currency options hedge would be most appropriate. Then, compare the most appropriate hedge to an unhedged strategy, and decide whether Baton Rouge should hedge its payables position.
ANSWER:
Forward hedge
Money market hedge
Option hedge
Amount Paid Total
Option per Unit Amount
Possible Premium Exercise (including Paid for
Spot Rate per Unit Option? the premium) S$1,000,000 Probability
Unhedged Strategy
Possible Total
Spot Rate Amount Paid Probability
Question 2
a -Compare and contrast the various exchange hedging strategies. Create a table for the comparison. Ensure to give the advantages and disadvantages of each strategy.
b. Explain how a forward contract can backfire. Illustrate using numbers not used in the text or covered in class.