U.S. aircraft manufacturer Boeing buys 10 Jet Engines from British Engine
Manufacturer Rolls Royce for £50 million payable in one year. Assume the
following market conditions:
U.S. interest rate: 6.00% p. a.
U.K interest rate: 6.50% p. a.
Spot exchange rate: $ 1.80/£
Forward exchange rate: $1.75/£ (1-year maturity)
Boeing wants to hedge its currency exposure to protect itself from any
adverse market movement. It has three choices:
a.
Currency Forward contract
b.
Hedging through investing in the money market
c.
Currency Options contract
Required:
a.
What should Boeing do if it decides to hedge its
exposure through a Currency Forward contract?
What is the dollar amount of the Forward contract?
b.
What steps Boeing should take if it decides to hedge its
exposure through investing appropriate $ amount in the money market so that the
net proceeds from such investment will be sufficient to pay-off £50 million in
one year’s time? What is the amount of dollar amount that Boeing should invest
now to hedge the exposure fully?
c.
What should Boeing do if it decides to hedge its
exposure through Currency Options Contract? Assume that in the Options market
Call Options on GBP is available with a Strike Price of $ 1.80/£ at a premium
of $0.018 per Pound. What will be the total cost of such Options contract to
Boeing?
d.
Use information in © above and calculate the Options
pay-off under the following alternative spot exchange rate scenarios:
$ 1.75/£
$ 1.80/£
$ 1.85/£
$ 1.90/£
Bonus Question:
(optional)
Can you calculate the Break-even Strike price of the Call Option at which
price there will be zero gain zero loss to Boeing taking into account the cost
of the Options Contract?
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