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Bernd lives in Berlin and uses the euro as his currency of denomination. Bernd has an accounts payable balance of $10 million due in 3 months. The...
1.Bernd lives in Berlin and uses the euro as his currency of denomination. Bernd has an accounts payable balance of $10 million due in 3 months. The spot rate is S€/$ = €1.20/$. Show the parts of a money market hedge of Bernd's exposure. Draw the risk exposures of the underlying position, the money market hedge, and the net position.
2. Aphorisms Inc. has an expected cash inflow of €1 million on an accounts receivable balance due in six months. The owner, Laozi (老子), wants to hedge this exposure with an option contract at a strike price of KCNY/€ = CNY 8.00/€ and with a due date in 6 months. At this strike price, call option and put option prices are, respectively, CallCNY/€ = CNY 1.00/€ and PutCNY/€ = CNY 2.00/€. Graph the following positions (a-c) on the figure below.
a. The exposure of Laozi's underlying position
b. The payoff of Laozi's option contract at expiration including the option premium
c. The payoff of Laozi's combined position including the option premium
3. U.K.-based OSA has an expected expense of €20 million due in one year. Actual expenses might be as low as €15 million or as high as €25 million. The expected future spot rate is E[S1£/€] = $0.6000/€. OSA wants to hedge the expected euro expense with a one-year €20 million euro forward contract.
d. Complete the following table assuming an exchange rate of £0.60/€ and uncertain expenses. Use a minus sign (-) to indicate a cash outflow and a plus sign ( + ) to indicate a cash inflow.
Volume uncertainty at an expected spot rate of £0.60/€
Underlying euro cash flows -€15 million -€20 million -€25 million
Cash flows of the forward hedge
Pound cash flows
Euro cash flows
Net position
Pound cash flows
Euro cash flows _____
