国际财务管理(英文版)课后习题答案9

CHAPTER8MANAGEMENTOFTRANSACTIONEXPOSURE

SUGGESTEDANSWERSANDSOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMS

QUESTIONS

1.Howwouldyoudefinetransactionexposure?Howisitdifferentfromeconomicexposure?

Answer:Transactionexposureisthesensitivityofrealizeddomesticcurrencyvaluesofthefirm’scontractualcashflowsdenominatedinforeigncurrenciestounexpectedchangesinexchangerates.Unlikeeconomicexposure,transactionexposureiswell-definedandshort-term.

2.Discussandcomparehedgingtransactionexposureusingtheforwardcontractvs.moneymarketinstruments.Whendothealternativehedgingapproachesproducethesameresult?

Answer:Hedgingtransactionexposurebyaforwardcontractisachievedbysellingorbuyingforeigncurrencyreceivablesorpayablesforward.Ontheotherhand,moneymarkethedgeisachievedbyborrowingorlendingthepresentvalueofforeigncurrencyreceivablesorpayables,therebycreatingoffsettingforeigncurrencypositions.Iftheinterestrateparityisholding,thetwohedgingmethodsareequivalent.

3.Discussandcomparethecostsofhedgingviatheforwardcontractandtheoptionscontract.

Answer:Thereisnoup-frontcostofhedgingbyforwardcontracts.Inthecaseofoptionshedging,however,hedgersshouldpaythepremiumsforthecontractsup-front.Thecostofforwardhedging,however,mayberealizedexpostwhenthehedgerregretshis/herhedgingdecision.

4.Whataretheadvantagesofacurrencyoptionscontractasahedgingtoolcomparedwiththeforwardcontract?

Answer:Themainadvantageofusingoptionscontractsforhedgingisthatthehedgercandecidewhethertoexerciseoptionsuponobservingtherealizedfutureexchangerate.Optionsthusprovideahedgeagainstexpostregretthatforwardhedgermighthavetosuffer.Hedgerscanonlyeliminatethedownsideriskwhileretainingtheupsidepotential.

5.SupposeyourcompanyhaspurchasedaputoptionontheGermanmarktomanageexchangeexposureassociatedwithanaccountreceivabledenominatedinthatcurrency.Inthiscase,yourcompanycanbesaidtohavean‘insurance’policyonitsreceivable.Explaininwhatsensethisisso.

Answer:Yourcompanyinthiscaseknowsinadvancethatitwillreceiveacertainminimumdollaramountnomatterwhatmighthappentothe$/€exchangerate.Furthermore,iftheGermanmarkappreciates,yourcompanywillbenefitfromtherisingeuro.

6.RecentsurveysofcorporateexchangeriskmanagementpracticesindicatethatmanyU.S.firmssimplydonothedge.Howwouldyouexplainthisresult?

Answer:Therecanbemanypossiblereasonsforthis.First,manyfirmsmayfeelthattheyarenotreallyexposedtoexchangeriskduetoproductdiversification,diversifiedmarketsfortheirproducts,etc.Second,firmsmaybeusingself-insuranceagainstexchangerisk.Third,firmsmayfeelthatshareholderscandiversifyexchangeriskthemselves,renderingcorporateriskmanagementunnecessary.

7.Shouldafirmhedge?Whyorwhynot?

Answer:Inaperfectcapitalmarket,firmsmaynotneedtohedgeexchangerisk.Butfirmscanaddtotheirvaluebyhedgingifmarketsareimperfect.First,ifmanagementknowsaboutthefirm’sexposurebetterthanshareholders,thefirm,notitsshareholders,shouldhedge.Second,firmsmaybeabletohedgeatalowercost.Third,ifdefaultcostsaresignificant,corporatehedgingcanbejustifiablebecauseitreducestheprobabilityofdefault.Fourth,ifthefirmfacesprogressivetaxes,itcanreducetaxobligationsbyhedgingwhichstabilizescorporateearnings.

8.Usinganexample,discussthepossibleeffectofhedgingonafirm’staxobligations.

Answer:Onecanuseanexamplesimilartotheonepresentedinthechapter.

9.Explaincontingentexposureanddiscusstheadvantagesofusingcurrencyoptionstomanagethistypeofcurrencyexposure.

Answer:Companiesmayencounterasituationwheretheymayormaynotfacecurrencyexposure.Inthissituation,companiesneedoptions,notobligations,tobuyorsellagivenamountofforeignexchangetheymayormaynotreceiveorhavetopay.Ifcompanieseitherhedgeusingforwardcontractsordonothedgeatall,theymayfacedefinitecurrencyexposure.

10.Explaincross-hedginganddiscussthefactorsdeterminingitseffectiveness.

Answer:Cross-hedginginvolveshedgingapositioninoneassetbytakingapositioninanotherasset.Theeffectivenessofcross-hedgingwoulddependonthestrengthandstabilityoftherelationshipbetweenthetwoassets.

PROBLEMS

1.CrayResearchsoldasupercomputertotheMaxPlanckInstituteinGermanyoncreditandinvoiced€10millionpayableinsixmonths.Currently,thesix-monthforwardexchangerateis$1.10/€andtheforeignexchangeadvisorforCrayResearchpredictsthatthespotrateislikelytobe$1.05/€insixmonths.

(a)Whatistheexpectedgain/lossfromtheforwardhedging?

(b)IfyouwerethefinancialmanagerofCrayResearch,wouldyourecommendhedgingthiseuroreceivable?Whyorwhynot?

(c)Supposetheforeignexchangeadvisorpredictsthatthefuturespotratewillbethesameastheforwardexchangeratequotedtoday.Wouldyourecommendhedginginthiscase?Whyorwhynot?

Solution:(a)Expectedgain($)=10,000,000(1.10–1.05)

=10,000,000(.05)

=$500,000.

(b)IwouldrecommendhedgingbecauseCrayResearchcanincreasetheexpecteddollarreceiptby$500,000andalsoeliminatetheexchangerisk.

(c)SinceIeliminateriskwithoutsacrificingdollarreceipt,Istillwouldrecommendhedging.

2.IBMpurchasedcomputerchipsfromNEC,aJapaneseelectronicsconcern,andwasbilled¥250millionpayableinthreemonths.Currently,thespotexchangerateis¥105/$andthethree-monthforwardrateis¥100/$.Thethree-monthmoneymarketinterestrateis8percentperannumintheU.S.and7percentperannuminJapan.ThemanagementofIBMdecidedtousethemoneymarkethedgetodealwiththisyenaccountpayable.

(a)Explaintheprocessofamoneymarkethedgeandcomputethedollarcostofmeetingtheyenobligation.

(b)Conductthecashflowanalysisofthemoneymarkethedge.

Solution:(a).Let’sfirstcomputethePVof¥250million,i.e.,

250m/1.0175=¥245,700,245.7

SoiftheaboveyenamountisinvestedtodayattheJapaneseinterestrateforthreemonths,thematurityvaluewillbeexactlyequalto¥25millionwhichistheamountofpayable.

Tobuytheaboveyenamounttoday,itwillcost:

$2,340,002.34=¥250,000,000/105.

Thedollarcostofmeetingthisyenobligationis$2,340,002.34asoftoday.

(b)

___________________________________________________________________

Transaction CF0 CF1

____________________________________________________________________

1.Buyyensspot -$2,340,002.34

withdollars ¥245,700,245.70

2.InvestinJapan -¥245,700,245.70 ¥250,000,000

3.Payyens -¥250,000,000

Netcashflow -$2,340,002.34

____________________________________________________________________

3.YouplantovisitGeneva,Switzerlandinthreemonthstoattendaninternationalbusinessconference.YouexpecttoincurthetotalcostofSF5,000forlodging,mealsandtransportationduringyourstay.Asoftoday,thespotexchangerateis$0.60/SFandthethree-monthforwardrateis$0.63/SF.Youcanbuythethree-monthcalloptiononSFwiththeexerciserateof$0.64/SFforthepremiumof$0.05perSF.Assumethatyourexpectedfuturespotexchangerateisthesameastheforwardrate.Thethree-monthinterestrateis6percentperannumintheUnitedStatesand4percentperannuminSwitzerland.

(a)CalculateyourexpecteddollarcostofbuyingSF5,000ifyouchoosetohedgeviacalloptiononSF.

(b)CalculatethefuturedollarcostofmeetingthisSFobligationifyoudecidetohedgeusingaforwardcontract.

(c)Atwhatfuturespotexchangeratewillyoubeindifferentbetweentheforwardandoptionmarkethedges?

(d)IllustratethefuturedollarcostsofmeetingtheSFpayableagainstthefuturespotexchangerateunderboththeoptionsandforwardmarkethedges.

Solution:(a)Totaloptionpremium=(.05)(5000)=$250.Inthreemonths,$250isworth$253.75=$250(1.015).Attheexpectedfuturespotrateof$0.63/SF,whichislessthantheexerciseprice,youdon’texpecttoexerciseoptions.Rather,youexpecttobuySwissfrancat$0.63/SF.SinceyouaregoingtobuySF5,000,youexpecttospend$3,150(=.63x5,000).Thus,thetotalexpectedcostofbuyingSF5,000willbethesumof$3,150and$253.75,i.e.,$3,403.75.

(b)$3,150=(.63)(5,000).

(c)$3,150=5,000x+253.75,wherexrepresentsthebreak-evenfuturespotrate.Solvingforx,weobtainx=$0.57925/SF.Notethatatthebreak-evenfuturespotrate,optionswillnotbeexercised.

(d)IftheSwissfrancappreciatesbeyond$0.64/SF,whichistheexercisepriceofcalloption,youwillexercisetheoptionandbuySF5,000for$3,200.ThetotalcostofbuyingSF5,000willbe$3,453.75=$3,200+$253.75.

$Cost

Optionshedge

Forwardhedge

$3,453.75

$3,150

0

0.579

0.64

(strikeprice)

$/SF

$253.75

Thisisthemaximumyouwillpay.

4.BoeingjustsignedacontracttosellaBoeing737aircrafttoAirFrance.AirFrancewillbebilled€20millionwhichispayableinoneyear.Thecurrentspotexchangerateis$1.05/€andtheone-yearforwardrateis$1.10/€.Theannualinterestrateis6.0%intheU.S.and5.0%inFrance.Boeingisconcernedwiththevolatileexchangeratebetweenthedollarandtheeuroandwouldliketohedgeexchangeexposure.

(a)Itisconsideringtwohedgingalternatives:selltheeuroproceedsfromthesaleforwardorborroweurosfromtheCreditLyonnaiseagainsttheeuroreceivable.Whichalternativewouldyourecommend?Why?

(b)Otherthingsbeingequal,atwhatforwardexchangeratewouldBoeingbeindifferentbetweenthetwohedgingmethods?

Solution:(a)Inthecaseofforwardhedge,thefuturedollarproceedswillbe(20,000,000)(1.10)=$22,000,000.Inthecaseofmoneymarkethedge(MMH),thefirmhastofirstborrowthePVofitseuroreceivable,i.e.,20,000,000/1.05=€19,047,619.Thenthefirmshouldexchangethiseuroamountintodollarsatthecurrentspotratetoreceive:(€19,047,619)($1.05/€)=$20,000,000,whichcanbeinvestedatthedollarinterestrateforoneyeartoyield:

$20,000,000(1.06)=$21,200,000.

Clearly,thefirmcanreceive$800,000morebyusingforwardhedging.

(b)AccordingtoIRP,F=S(1+i$)/(1+iF).Thusthe“indifferent”forwardratewillbe:

F=1.05(1.06)/1.05=$1.06/€.

5.SupposethatBaltimoreMachinerysoldadrillingmachinetoaSwissfirmandgavetheSwissclientachoiceofpayingeither$10,000orSF15,000inthreemonths.

(a)Intheaboveexample,BaltimoreMachineryeffectivelygavetheSwissclientafreeoptiontobuyupto$10,000dollarsusingSwissfranc.Whatisthe‘implied’exerciseexchangerate?

(b)Ifthespotexchangerateturnsouttobe$0.62/SF,whichcurrencydoyouthinktheSwissclientwillchoosetouseforpayment?WhatisthevalueofthisfreeoptionfortheSwissclient?

(c)WhatisthebestwayforBaltimoreMachinerytodealwiththeexchangeexposure?

Solution:(a)Theimpliedexercise(price)rateis:10,000/15,000=$0.6667/SF.

(b)IftheSwissclientchoosestopay$10,000,itwillcostSF16,129(=10,000/.62).SincetheSwissclienthasanoptiontopaySF15,000,itwillchoosetodoso.ThevalueofthisoptionisobviouslySF1,129(=SF16,129-SF15,000).

(c)BaltimoreMachineryfacesacontingentexposureinthesensethatitmayormaynotreceiveSF15,000inthefuture.ThefirmthuscanhedgethisexposurebybuyingaputoptiononSF15,000.

6.PrincessCruiseCompany(PCC)purchasedashipfromMitsubishiHeavyIndustry.PCCowesMitsubishiHeavyIndustry500millionyeninoneyear.Thecurrentspotrateis124yenperdollarandtheone-yearforwardrateis110yenperdollar.Theannualinterestrateis5%inJapanand8%intheU.S.PCCcanalsobuyaone-yearcalloptiononyenatthestrikepriceof$.0081peryenforapremiumof.014centsperyen.

(a)Computethefuturedollarcostsofmeetingthisobligationusingthemoneymarkethedgeandtheforwardhedges.

(b)Assumingthattheforwardexchangerateisthebestpredictorofthefuturespotrate,computetheexpectedfuturedollarcostofmeetingthisobligationwhentheoptionhedgeisused.

(c)AtwhatfuturespotratedoyouthinkPCCmaybeindifferentbetweentheoptionandforwardhedge?

Solution:(a)Inthecaseofforwardhedge,thedollarcostwillbe500,000,000/110=$4,545,455.Inthecaseofmoneymarkethedge,thefuturedollarcostwillbe:500,000,000(1.08)/(1.05)(124)

=$4,147,465.

(b)Theoptionpremiumis:(.014/100)(500,000,000)=$70,000.Itsfuturevaluewillbe$70,000(1.08)=$75,600.

Attheexpectedfuturespotrateof$.0091(=1/110),whichishigherthantheexerciseof$.0081,PCCwillexerciseitscalloptionandbuy¥500,000,000for$4,050,000(=500,000,000x.0081).

Thetotalexpectedcostwillthusbe$4,125,600,whichisthesumof$75,600and$4,050,000.

(c)Whentheoptionhedgeisused,PCCwillspend“atmost”$4,125,000.Ontheotherhand,whentheforwardhedgingisused,PCCwillhavetospend$4,545,455regardlessofthefuturespotrate.Thismeansthattheoptionshedgedominatestheforwardhedge.Atnofuturespotrate,PCCwillbeindifferentbetweenforwardandoptionshedges.

7.Airbussoldanaircraft,A400,toDeltaAirlines,aU.S.company,andbilled$30millionpayableinsixmonths.Airbusisconcernedwiththeeuroproceedsfrominternationalsalesandwouldliketocontrolexchangerisk.Thecurrentspotexchangerateis$1.05/€andsix-monthforwardexchangerateis$1.10/€atthemoment.Airbuscanbuyasix-monthputoptiononU.S.dollarswithastrikepriceof€0.95/$forapremiumof€0.02perU.S.dollar.Currently,six-monthinterestrateis2.5%intheeurozoneand3.0%intheU.S.

ComputetheguaranteedeuroproceedsfromtheAmericansaleifAirbusdecidestohedgeusingaforwardcontract.

IfAirbusdecidestohedgeusingmoneymarketinstruments,whatactiondoesAirbusneedtotake?WhatwouldbetheguaranteedeuroproceedsfromtheAmericansaleinthiscase?

IfAirbusdecidestohedgeusingputoptionsonU.S.dollars,whatwouldbethe‘expected’europroceedsfromtheAmericansale?AssumethatAirbusregardsthecurrentforwardexchangerateasanunbiasedpredictorofthefuturespotexchangerate.

AtwhatfuturespotexchangeratedoyouthinkAirbuswillbeindifferentbetweentheoptionandmoneymarkethedge?

Solution:

a.Airbuswillsell$30millionforwardfor€27,272,727=($30,000,000)/($1.10/€).

b.Airbuswillborrowthepresentvalueofthedollarreceivable,i.e.,$29,126,214=$30,000,000/1.03,andthensellthedollarproceedsspotforeuros:€27,739,251.ThisistheeuroamountthatAirbusisgoingtokeep.

c.Sincetheexpectedfuturespotrateislessthanthestrikepriceoftheputoption,i.e.,€0.9091<€0.95,Airbusexpectstoexercisetheoptionandreceive€28,500,000=($30,000,000)(€0.95/$).Thisisgrossproceeds.Airbusspent€600,000(=0.02x30,000,000)upfrontfortheoptionanditsfuturecostisequalto€615,000=€600,000x1.025.ThustheneteuroproceedsfromtheAmericansaleis€27,885,000,whichisthedifferencebetweenthegrossproceedsandtheoptioncosts.

d.Attheindifferentfuturespotrate,thefollowingwillhold:

€28,432,732=ST(30,000,000)-€615,000.

SolvingforST,weobtainthe“indifference”futurespotexchangerate,i.e.,€0.9683/$,or$1.0327/€.Notethat€28,432,732isthefuturevalueoftheproceedsundermoneymarkethedging:

€28,432,732=(€27,739,251)(1.025).

SuggestedsolutionforMiniCase:ChaseOptions,Inc.

[SeeChapter13forthecasetext]

ChaseOptions,Inc.

HedgingForeignCurrencyExposureThroughCurrencyOptions

HarveyA.Poniachek

I.CaseSummary

Thiscasereviewstheforeignexchangeoptionsmarketandhedging.Itpresentsvariousinternationaltransactionsthatrequirecurrencyoptionshedgingstrategiesbythecorporationsinvolved.Seventransactionsunderavarietyofcircumstancesareintroducedthatrequirehedgingbycurrencyoptions.Thetransactionsinvolvehedgingofdividendremittances,portfolioinvestmentexposure,andstrategiceconomiccompetitiveness.Marketquotationsareprovidedforoptions(andoptionshedgingratios),forwards,andinterestratesforvariousmaturities.

II.CaseObjective.

Thecaseintroducesthestudenttotheprinciplesofcurrencyoptionsmarketandhedgingstrategies.Thetransactionsareofvarioustypesthatoftenconfrontcompaniesthatareinvolvedinextensiveinternationalbusinessormultinationalcorporations.Thecaseinducesstudentstoacquirehands-onexperienceinaddressingspecificexposureandhedgingconcerns,includinghowtoapplyvariousmarketquotations,whichhedgingstrategyismostsuitable,andhowtoaddressexposureinforeigncurrencythroughcrosshedgingpolicies.

III.ProposedAssignmentSolution

1.ThecompanyexpectsDM100millioninrepatriatedprofits,anddoesnotwanttheDM/$exchangerateatwhichtheyconvertthoseprofitstoriseabove1.70.TheycanhedgethisexposureusingDMputoptionswithastrikepriceof1.70.Ifthespotraterisesabove1.70,theycanexercisetheoption,whileifthatratefallstheycanenjoyadditionalprofitsfromfavorableexchangeratemovements.

Topurchasetheoptionswouldrequireanup-frontpremiumof:

DM100,000,000x0.0164=DM1,640,000.

Withastrikepriceof1.70DM/$,thiswouldassuretheU.S.companyofreceivingatleast:

DM100,000,000–DM1,640,000x(1+0.085106x272/360)

=DM98,254,544/1.70DM/$=$57,796,791

byexercisingtheoptioniftheDMdepreciated.Notethattheproceedsfromtherepatriatedprofitsarereducedbythepremiumpaid,whichisfurtheradjustedbytheinterestforegoneonthisamount.

However,iftheDMweretoappreciaterelativetothedollar,thecompanywouldallowtheoptiontoexpire,andenjoygreaterdollarproceedsfromthisincrease.

Shouldforwardcontractsbeusedtohedgethisexposure,theproceedsreceivedwouldbe:

DM100,000,000/1.6725DM/$=$59,790,732,

regardlessofthemovementoftheDM/$exchangerate.Whilethisamountisalmost$2millionmorethanthatrealizedusingoptionhedgesabove,thereisnoflexibilityregardingtheexercisedate;ifthisdatediffersfromthatatwhichtherepatriateprofitsareavailable,thecompanymaybeexposedtoadditionalfurthercurrentexposure.Further,thereisnoopportunitytoenjoyanyappreciationintheDM.

IfthecompanyweretobuyDMputsasabove,andsellanequivalentamountincallswithstrikeprice1.647,thepremiumpaidwouldbeexactlyoffsetbythepremiumreceived.Thiswouldassurethattheexchangeraterealizedwouldfallbetween1.647and1.700.Iftheraterisesabove1.700,thecompanywillexerciseitsputoption,andifitfellbelow1.647,theotherpartywoulduseitscall;foranyrateinbetween,bothoptionswouldexpireworthless.Theproceedsrealizedwouldthenfallbetween:

DM100,00,000/1.647DM/$=$60,716,454

and

DM100,000,000/1.700DM/$=$58,823,529.

Thiswouldallowthecompanysomeupsidepotential,whileguaranteeingproceedsatleast$1milliongreaterthantheminimumforsimplybuyingaputasabove.

Buy/SellOptions

DM/$Spot

PutPayoff

“Put”Profits

CallPayoff

“Call”Profits

NetProfit

1.60

(1,742,846)

0

1,742,846

60,716,454

60,716,454

1.61

(1,742,846)

0

1,742,846

60,716,454

60,716,454

1.62

(1,742,846)

0

1,742,846

60,716,454

60,716,454

1.63

(1,742,846)

0

1,742,846

60,716,454

60,716,454

1.64

(1,742,846)

0

1,742,846

60,716,454

60,716,454

1.65

(1,742,846)

60,606,061

1,742,846

0

60,606,061

1.66

(1,742,846)

60,240,964

1,742,846

0

60,240,964

1.67

(1,742,846)

59,880,240

1,742,846

0

59,880,240

1.68

(1,742,846)

59,523,810

1,742,846

0

59,523,810

1.69

(1,742,846)

59,171,598

1,742,846

0

59,171,598

1.70

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.71

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.72

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.73

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.74

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.75

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.76

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.77

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.78

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.79

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.80

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.81

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.82

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.83

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.84

(1,742,846)

58,823,529

1,742,846

0

58,823,529

1.85

(1,742,846)

58,823,529

1,742,846

0

58,823,529

Sincethefirmbelievesthatthereisagoodchancethatthepoundsterlingwillweaken,lockingthemintoaforwardcontractwouldnotbeappropriate,becausetheywouldlosetheopportunitytoprofitfromthisweakening.Theirhedgestrategyshouldfollowforanupsidepotentialtomatchtheirviewpoint.Therefore,theyshouldpurchasesterlingcalloptions,payingapremiumof:

5,000,000STGx0.0176=88,000STG.

Ifthedollarstrengthensagainstthepound,thefirmallowstheoptiontoexpire,andbuyssterlinginthespotmarketatacheaperpricethantheywouldhavepaidforaforwardcontract;otherwise,thesterlingcallsprotectagainstunfavorabledepreciationofthedollar.

Becausethefundmanagerisuncertainwhenhewillsellthebonds,herequiresahedgewhichwillallowflexibilityastotheexercisedate.Thus,optionsarethebestinstrumentforhimtouse.HecanbuyA$putstolockinafloorof0.72A$/$.Sinceheiswillingtoforegoanyfurthercurrencyappreciation,hecansellA$callswithastrikepriceof0.8025A$/$todefraythecostofhishedge(infactheearnsanetpremiumofA$100,000,000x(0.007234–0.007211)=A$2,300),whileknowingthathecan’treceivelessthan0.72A$/$whenredeeminghisinvestment,andcanbenefitfromasmallappreciationoftheA$.

Example#3:

Problem:HedgeprincipaldenominatedinA$intoUS$.Forgoupsidepotentialtobuyfloorprotection.

I. Hedgebywritingcallsandbuyingputs

1) Writecallsfor$/A$@0.8025

Buyputsfor$/A$@0.72

#contractsneeded=PrincipalinA$/Contractsize

100,000,000A$/100,000A$=100

2) Revenuefromsaleofcalls=(#contracts)(sizeofcontract)(premium)

$75,573=(100)(100,000A$)(.007234$/A$)(1+.0825195/360)

3) Totalcostofputs=(#contracts)(sizeofcontract)(premium)

$75,332=(100)(100,000A$)(.007211$/A$)(1+.0825195/360)

4) Putpayoff

Ifspotfallsbelow0.72,fundmanagerwillexerciseput

Ifspotrisesabove0.72,fundmanagerwillletputexpire

5) Callpayoff

Ifspotrisesabove.8025,callwillbeexercised

Ifspotfallsbelow.8025,callwillexpire

6) Netpayoff

SeefollowingTablefornetpayoff

AustralianDollarBondHedge

StrikePrice

PutPayoff

“Put”Principal

CallPayoff

“Call”Principal

NetProfit

0.60

(75,332)

72,000,000

75,573

0

72,000,241

0.61

(75,332)

72,000,000

75,573

0

72,000,241

0.62

(75,332)

72,000,000

75,573

0

72,000,241

0.63

(75,332)

72,000,000

75,573

0

72,000,241

0.64

(75,332)

72,000,000

75,573

0

72,000,241

0.65

(75,332)

72,000,000

75,573

0

72,000,241

0.66

(75,332)

72,000,000

75,573

0

72,000,241

0.67

(75,332)

72,000,000

75,573

0

72,000,241

0.68

(75,332)

72,000,000

75,573

0

72,000,241

0.69

(75,332)

72,000,000

75,573

0

72,000,241

0.70

(75,332)

72,000,000

75,573

0

72,000,241

0.71

(75,332)

72,000,000

75,573

0

72,000,241

0.72

(75,332)

72,000,000

75,573

0

72,000,241

0.73

(75,332)

73,000,000

75,573

0

73,000,241

0.74

(75,332)

74,000,000

75,573

0

74,000,241

0.75

(75,332)

75,000,000

75,573

0

75,000,241

0.76

(75,332)

76,000,000

75,573

0

76,000,241

0.77

(75,332)

77,000,000

75,573

0

77,000,241

0.78

(75,332)

78,000,000

75,573

0

78,000,241

0.79

(75,332)

79,000,000

75,573

0

79,000,241

0.80

(75,332)

80,000,000

75,573

0

80,000,241

0.81

(75,332)

0

75,573

80,250,000

80,250,241

0.82

(75,332)

0

75,573

80,250,000

80,250,241

0.83

(75,332)

0

75,573

80,250,000

80,250,241

0.84

(75,332)

0

75,573

80,250,000

80,250,241

0.85

(75,332)

0

75,573

80,250,000

80,250,241

4.TheGermancompanyisbiddingonacontractwhichtheycannotbecertainofwinning.Thus,theneedtoexecuteacurrencytransactionissimilarlyuncertain,andusingaforwardorfuturesasahedgeisinappropriate,becauseitwouldforcethemtoperformeveniftheydonotwinthecontract.

Usingasterlingputoptionasahedgeforthistransactionmakesthemostsense.Forapremiumof:

12millionSTGx0.0161=193,200STG,

theycanassurethemselvesthatadversemovementsinthepoundsterlingexchangeratewillnotdiminishtheprofitabilityoftheproject(andhencethefeasibilityoftheirbid),whileatthesametimeallowingthepotentialforgainsfromsterlingappreciation.

5.SinceAMCinconcernedabouttheadverseeffectsthatastrengtheningofthedollarwouldhaveonitsbusiness,weneedtocreateasituationinwhichitwillprofitfromsuchanappreciation.Purchasingayenputoradollarcallwillachievethisobjective.ThedatainExhibit1,row7representa10percentappreciationofthedollar(128.15strikevs.116.5forwardrate)andcanbeusedtohedgeagainstasimilarappreciationofthedollar.

Foreverymillionyenofhedging,thecostwouldbe:

Yen100,000,000x0.000127=127Yen.

Todeterminethebreakevenpoint,weneedtocomputethevalueofthisoptionifthedollarappreciated10percent(spotroseto128.15),andsubtractfromitthepremiumwepaid.Thisprofitwouldbecomparedwiththeprofitearnedonfiveto10percentofAMC’ssales(whichwouldbelostasaresultofthedollarappreciation).Thenumberofoptionstobepurchasedwhichwouldequalizethesetwoquantitieswouldrepresentthebreakevenpoint.

Example#5:

HedgetheeconomiccostofthedepreciatingYentoAMC.

IfweassumethatAMCsalesfallindirectproportiontodepreciationintheyen(i.e.,a10percentdeclineinyenand10percentdeclineinsales),thenwecanhedgethefullvalueofAMC’ssales.Ihaveassumed$100millioninsales.

1) Buyyenputs

#contractsneeded=ExpectedSales*Current¥/$R