Hedging alternatives to reduce exchange rate risk

Assignment Help Financial Management

Reference no: EM132056770

AJ Industries (AJI), a Frederick, MD based firm, has just signed a contract to purchase a piece of very sophisticated chip making equipment from Li Van Weaver, Ltd. (LVW), an Austrian firm based in Salzburg, for €1,250,000. The sale was made in May 2016 with payment due six months later. Because this is a sizable contract for AJI and because the contract is in EUR rather than USD, CFO of AJI is considering several hedging alternatives to reduce the exchange rate risk arising from the purchase and hired you as a consultant. To help the CFO make a hedging decision you have gathered the following information.

The spot exchange rate is $0.8924/€

The six month forward rate is $0.8750/€

AJI’s cost of capital is 8%

The Euro zone 6-month borrowing rate is 6%

The Euro zone 6-month lending rate is 4%

The U.S. 6-month borrowing rate is 3%

The U.S. 6-month lending rate is 1%

November 2013 put options for €625,000: strike price $0.9000, premium is 1.5%? November 2013 call options for €625,000: strike price $0.9000, premium is 1.0%

1-What type of exposure is AJI facing? How much?

2-If AJI carries out a forward hedge, how much dollars will they need to fulfill this contract in November 2016?

3-Explain how AJI might carry out a money market hedge. (Hint: Just explain each step of the money market hedge – no need to do any calculations.)

4-What is the dollar value of this contract if AJI chooses a money market hedge?

5-CFO would like to consider a hedging strategy using F/X options. Evaluate the outcome of an options hedge. Draw the payoff function for this option hedge.

Reference no: EM132056770

Questions Cloud

Confidence interval for the true average speed : Construct a 99% confidence interval for the true average speed of a thunderstorm in his area.

Calculating option values using given data : The price of Swearengen, Inc., stock will be either $72 or $94 at the end of the year. Call options are available with one year to expiration.

Capturing and prosecuting the terrorist : If he releases the hostages, even though the government has every intention of capturing and prosecuting the terrorist once his hostages are released?

Determine the sample proportion that was used : Determine the sample proportion that was used to build this confidence interval.

Hedging alternatives to reduce exchange rate risk : CFO of AJI is considering several hedging alternatives to reduce the exchange rate risk arising from the purchase and hired you as a consultant.

How much should be charged to play this game : If any other card (2-10) is drawn, the player wins $2. How much should be charged to play this game in order for it to be fair?

Apply the empirical rule and the chebyshev rule : Consider a population of 1024 mutual funds that primarily invest in large companies You have determined that p, the mean one-year total percentage return

Find mean-variance and standard deviation of number : If a sample of 400 federal government employees are selected, find the mean, variance, and standard deviation of the number who use the US Postal Service.

Determine the number of kanban card sets needed : In setting up a kanban control system, you need to determine the number of kanban card sets needed.

User Account

All Pages