Chapter 11 Example of Hedging Short term transactions (assume today is Mar13, 2013)
Your company has a net exposure of 515,000 Euros inflows due in 60 days. You expect payment in 60 days at which time your company will convert the Euros into US dollars.
The current Spot rate on the Euro is $1.3973
Your company has assumed that the expected spot rate on the Euro in 60 days will be selling at the same rate as today. In other words, the expected change in the spot rate over the next 60 days is 0.0%. However, the standard deviation of the expected change in the spot rate is 11% per year (4.5% per 60 days)
1)What is the expected value of the 515,000 Euros in 60 days? What is the 95% Value-at-Risk measure in US dollars for this transaction? Remember that a 5% one-sided tail is approximately 1.65 standard deviations away from the mean.
2)Suppose that your company has purchased a forecast for the Euro and the Forecaster has provided the following probability distribution for the spot price on the Euro in 60 days.
Spot Rate in 60 days / Probability$ 1.30 / 5%
$ 1.34 / 10%
$ 1.37 / 20%
$ 1.39 / 30%
$ 1.41 / 20%
$ 1.43 / 10%
$ 1.45 / 5%
Using the provided forecast, calculate the US dollar value of the receivables in 60 days under each conditional spot rate assuming there is no hedge of the receivables in place. In addition, what is the expected value of the receivables in 60 days using the provided forecast?
3)Set up a money market hedge that will lock in a value today of the receivables in 90 days. Use the information provided by me for the appropriate bid/ask spreads. You can invest US dollars at 1% per year and you can invest Euros at 1.25% per year. You can borrow US dollars at 7.5% and you can borrow Euros at 7.75%. Compare the value of the receivables using a hedge vs no hedge chart using the forecast purchased. What is the probability that the hedge will be beneficial?
4)Describe a theoretical forward transaction that will hedge the exchange rate exposure. Assume you could get a forward rate at $1.3915/1Euro. What is the US dollar value of the Accounts Receivables in 60 days using a forward contract? What is the upside to using a theoretical forward contract versus a money market hedge?
5)Describe a theoretical Junfutures contract hedge that is available today assuming the Futures contract matures on Jun 19, 2013 and the futures contract price is $1.3922 (Describe the date, number of contracts, whether you are purchasing or selling, and assume that the margin is $1500 per contract). What are the limitations of using a futures hedge? Your company has a policy of under-hedging odd dollar transactions. How is it different from the forward contract described above? What is thenet value of the receivables if the spot price in 60 days on the Euro is $1.31? What is the net value of the receivables if thespot price in 60 days on the Euro is $1.40?
6)Describe a currency option strategy using an optionthat will eliminate some of the exchange rate exposure (use an exercise price of $1.38). Euro option on are for 10,000 units. (Assume the options expire on the exact day that payment is received). Again you will be under-hedging. (The price of a May strike = 1.38 call option is $.04 and a May strike = 1.38put option is $.03). Using the forecast purchased, compare the option hedge to the no hedge scenario. What is the probability that the option hedge is beneficial?