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Graylon, Inc

Graylon, Inc., based in Washington, exports products to a German firm and will receive payment of €200,000 in three months. On June 1, the spot rate of the euro was $1.12, and the 3-month forward rate was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell €200,000 forward in three months. The spot rate of the euro on September 1 is $1.15. Graylon will receive $____ for the euros.

224,000
220,000
200,000
230,000

To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency.

receivable; purchase
payable; sell
payable; purchase
none of the above

The greater the variability of a currency, the ____ will be the premium of a call option on this currency, and the ____ will be the premium of a put option on this currency, other things equal.

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greater; lower
greater; greater
lower; greater
lower; lower
  A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$) receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally? $74,000. $84,000. $75,000. $85,000.           A U.S. corporation has purchased currency call options to hedge a 70,000 pound payable. The premium is $.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the total amount paid by the corporation if it acts rationally? $33,600. $46,900. $44,100. $36,400.    

Sometimes the overall performance of an MNC may already be insulated by offsetting effects between subsidiaries and it may not be necessary to hedge the position of each individual subsidiary.

 True

 False

When currency options are not standardized and traded over-the-counter, there is ____ liquidity and a ____ bid/ask spread.

less; narrower
more; narrower
more; wider
less; wider

When you own ____, there is no obligation on your part; however, when you own ____, there is an obligation on your part.

call options; put options
futures contracts; call options
forward contracts; futures contracts
put options; forward contracts

If Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in Japanese yen but wanted to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be:

a money market hedge.
a forward sale of yen.
purchasing yen call options.
purchasing yen put options.
selling yen put options.

 U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if the bid is accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against exchange rate exposure by:

selling futures in francs.
buying futures in francs.
buying franc put options.
buying franc call options.

———————————————————————————————————————————–

Money Market Versus Call Option Hedging. You expect that inflation in the United States will be 3%, versus 5% in the United Kingdom. The expected spot rate in one year is $1.8756. The spot rate of the pound as of today is $1.8000. The annual interest rate in the United States is 6% versus an annual interest rate in the United Kingdom of 8%. Call options are available with an exercise price of $1.79, an expiration date of one year from today, and a premium of $.03 per unit. Your firm in the United States expects to need 1 million pounds in one year to pay for imports. Use the unhedged strategy to deal with the exchange rate risk. Estimate the dollar cash flows you will need as a result of an unhedged strategy.

Money Market Versus Call Option Hedging. You expect that inflation in the United States will be 3%, versus 5% in the United Kingdom. The expected spot rate in one year is $1.8756. The spot rate of the pound as of today is $1.8000. The annual interest rate in the United States is 6% versus an annual interest rate in the United Kingdom of 8%. Call options are available with an exercise price of $1.79, an expiration date of one year from today, and a premium of $.03 per unit. Your firm in the United States expects to need 1 million pounds in one year to pay for imports. Use the call option hedge strategy to deal with the exchange rate risk. Estimate the dollar cash flows you will need as a result of a call option hedge.

Hedging Payables. Assume the following information: 90 day U.S. interest rate = 4% 90 day Malaysian interest rate = 3% 90 day forward rate of Malaysian ringgit = $.400 Spot rate of Malaysian ringgit = $.404 Assume that the Santa Barbara Co. in the United States will need 300,000 ringgit in 90 days. It wishes to hedge this payables position. Would it be better off using a forward hedge or a money market hedge? Substantiate your answer with estimated costs for each type of hedge.

$145,000 (money market hedge), $140,753 (forward hedge); the corporation should use a money market hedge
$145,000 (money market hedge), $152,450 (forward hedge); the corporation should use a forward hedge
$135,000 (money market hedge), $122,377 (forward hedge); the corporation should use a money market hedge
$122,377 (money market hedge), $120,000 (forward hedge); the corporation should use a forward hedge

Money Market Versus Put Option Hedge. Narto Co. (a U.S. firm) exports to Switzerland and expects to receive 500,000 Swiss francs in one year. The one-year U.S. interest rate is 5% when investing funds and 7% when borrowing funds. The one-year Swiss interest rate is 9% when investing funds, and 11% when borrowing funds. The spot rate of the Swiss franc is $.80. Narto expects that the spot rate of the Swiss franc will be $.75 in one year. There is a put option available on Swiss francs with an exercise price of $.79 and a premium of $.02. Determine the amount of dollars that Narto Co. will receive at the end of one year if it implements a money market hedge.

$345,370
$397,446
$385,000
$378,378

Hedging with Forward Contracts. Explain how a U.S. corporation could hedge net receivables in Malaysian ringgit with a forward contract. Explain how a U.S. corporation could hedge payables in Canadian dollars with a forward contract.

The U.S. corporation could buy ringgit forward using a forward contract. The U.S. corporation could buy Canadian dollars forward using a forward contract.
The U.S. corporation could buy ringgit forward using a forward contract. The U.S. corporation could sell Canadian dollars forward using a forward contract.
The U.S. corporation could sell ringgit forward using a forward contract. The U.S. corporation could sell Canadian dollars forward using a forward contract.
The U.S. corporation could sell ringgit forward using a forward contract. The U.S. corporation could buy Canadian dollars forward using a forward contract.

Currency Options. Relate the use of currency options to hedging net payables and receivables. That is, when should currency puts be purchased, and when should currency calls be purchased? Why would Cleveland, Inc., consider hedging net payables or net receiv¬ables with currency options rather than forward contracts? What are the disadvantages of hedging with currency options as opposed to forward contracts? A disadvantage of currency options is that a price (premium) is paid for the option itself. The only payment by a firm using a forward contract is the exchange of a currency as specified in the contract.

Currency put options should be purchased to hedge net payables. Currency call options should be purchased to hedge net receivables. Currency options provide not only a hedge, but they also provide flexibility since they require a commitment to buy or sell a currency (whereas the forward contract does not).
Currency put options should be purchased to hedge net payables. Currency call options should be purchased to hedge net receivables. Currency options provide not only a hedge, but they also provide flexibility since they do not require a commitment to buy or sell a currency (whereas the forward contract does).
Currency call options should be purchased to hedge net payables. Currency put options should be purchased to hedge net receivables. Currency options provide not only a hedge, but they also provide flexibility since they do not require a commitment to buy or sell a currency (whereas the forward contract does).
Currency call options should be purchased to hedge net payables. Currency put options should be purchased to hedge net receivables. Currency options provide not only a hedge, but they also provide flexibility since they require a commitment to buy or sell a currency (whereas the forward contract does not).

Real Cost of Hedging Payables. Assume that Suffolk Co. negotiated a forward contract to purchase 200,000 British pounds in 90 days. The 90 day forward rate was $1.40 per British pound. The pounds to be purchased were to be used to purchase British supplies. On the day the pounds were delivered in accordance with the forward contract, the spot rate of the British pound was $1.44. What was the real cost of hedging the payables for this U.S. firm? What was the real cost of hedging the payables for this U.S. firm if the spot rate of the British pound was $1.34?

–$8,000, $280,000, $12,000
$8,000, $179,000, $13,000
–$7,450, $280,000, $12,000
$7,450, $179,000, $13,000

Hedging Decision on Receivables. Assume the following information: 180 day U.S. interest rate = 8% 180 day British interest rate = 9% 180 day forward rate of British pound = $1.50 Spot rate of British pound = $1.48 Assume that Riverside Corp. from the United States will receive 400,000 pounds in 180 days. Would it be better off using a forward hedge or a money market hedge? Substantiate your answer with estimated revenue for each type of hedge.

$500,000 (forward hedge), $489,337 (money market hedge); the corporation should use a forward hedge
$540,000(forward hedge), $586,578 (money market hedge); the corporation should use a money market hedge
$600,000 (forward hedge), $586,569 (money market hedge); the corporation should use a forward hedge
$640,000 (forward hedge), $681,780 (money market hedge); the corporation should use a money market hedge

Money Market Versus Call Option Hedging. You expect that inflation in the United States will be 3%, versus 5% in the United Kingdom. The expected spot rate in one year is $1.8756. The spot rate of the pound as of today is $1.8000. The annual interest rate in the United States is 6% versus an annual interest rate in the United Kingdom of 8%. Call options are available with an exercise price of $1.79, an expiration date of one year from today, and a premium of $.03 per unit. Your firm in the United States expects to need 1 million pounds in one year to pay for imports. Use the money market hedge strategy to deal with the exchange rate risk. Estimate the dollar cash flows you will need as a result of a money market hedge.

Continuous Hedging. Cornell Co. purchases computer chips denominated in euros on a monthly basis from a Dutch supplier. To hedge its exchange rate risk, this U.S. firm negotiates a three-month forward contract three months before the next order will arrive. In other words, Cornell is always covered for the next three monthly shipments. Because Cornell consistently hedges in this manner, it is not concerned with exchange rate movements. Is Cornell insulated from exchange rate movements? Explain.

No. Cornell is exposed to exchange rate risk over time because the forward rate does not change over time. If the euro appreciates, the forward rate of the euro will likely rise over time, which increases the necessary payment by Cornell.
No. Cornell is exposed to exchange rate risk over time because the forward rate changes over time. If the euro appreciates, the forward rate of the euro will likely rise over time, which increases the necessary payment by Cornell.
Yes. Cornell is exposed to exchange rate risk over time because the forward rate changes over time. If the euro appreciates, the forward rate of the euro will likely rise over time, which increases the necessary payment by Cornell.
Yes. Cornell is exposed to exchange rate risk over time because the forward rate does not change over time. If the euro appreciates, the forward rate of the euro will likely rise over time, which increases the necessary payment by Cornell.
 
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