Concept explainers
Your start-up company has negotiated a contract to provide a database installation for a manufacturing company in Poland. That firm has agreed to pay you $100,000 in three months when the installation will occur. However, it insists on paying in Polish zloty (PLN). You don’t want to lose the deal (the company is your first client!), but you are worried about the exchange rate risk. In particular, you are worried the zloty could depreciate relative to the dollar. You contact Fortis Bank in Poland to see if you can lock in an exchange rate for the zloty in advance.
a. Assume that the current spot exchange rate is 2.3117 PLN per U.S. dollar and that the three month forward exchange rate is 2.2595 PLN per U.S. dollar. How many zloty should you demand in the contract to receive $100,000 in three months if you hedge the exchange rate risk with a forward contract?
b. Given the bank forward rates in (a), were short-term interest rates higher or lower in Poland than in the United States at the time? Explain.
Want to see the full answer?
Check out a sample textbook solutionChapter 23 Solutions
Fundamentals of Corporate Finance (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series)
- 2) A Canadian company sold 1000 computers for the price of $1000 CND to an Indian company when exchange rate was 1 CND= 65 R. invoice is due after 90 days and when Indian company is about to pay the invoice, exchange rate s 1 CND= 75 R. How much is the loss for Indian company? What are the methods to avoid this risk?arrow_forwardLagoon (a U.S. firm) will be receiving 4 million British pounds in one year. It will need to make a payment of 3 million Polish zloty in one year. It has no other exchange rate risk at this time. However, it needs to buy supplies and can purchase them from Switzerland, Hong Kong, Canada, or Ecuador. Another alternative is that it could purchase one-fourth of the supplies from each of those 4 countries. The supplies will be invoiced in the currency of the country where they are imported from. Lagoon Co. believes that none of the sources of the imports would provide a clear cost advantage. As of today, the dollar cost of these supplies would be about $6 million regardless of the source that will provide the supplies. The spot rates today are as follows: British pound = $1.80 Swiss franc = $.60 Polish zloty = $.30 Hong Kong dollar = $.14 Canadian dollar = $.60 The movements of the pound and the Swiss franc and the Polish zloty against the dollar are highly correlated. The Hong Kong…arrow_forwardDLY is a new car’s company in Germany. They intend to start production next year. DLY has a franchise in the US. Economists believe that the euro will depreciate next year. Advice the company what should they do to manage the currency riskarrow_forward
- Suppose that Warner Co is a U.S.-based MNC with a major subsidiary in France. This French subsidiary deals in euros, and is expected to earn 35 million euros next year. However, as these euros will stay with the subsidiary in France, Warner is concerned about translation exposure. To hedge against this translation exposure, Warner decides to sell 35 million euros forward. Warner can then purchase euros at the prevailing spot rate in one year to fulfill the forward contract. Suppose that the forward rate for euros is $1.20 and the spot rate for euros currently is also $1.20. If the euro depreciates to a weighted average exchange rate of $1.10 in one year, than the translated earnings for the French subsidiary will be $ $ million. However, if the value of the euro remains at $1.20, the translated earnings of the French subsidiary would be million. This means that a depreciation of the euro would cause the translated earnings of the French subsidiary to decreasarrow_forwardYou are a U.S. importer and just placed an order of antiques worth £100,000 from a U.K supplier. You owe £100,000 to the U.K seller in one year. You are concerned about the dollar cost of this purchase in one year and decide to hedge your exchange rate risk using money market hedge. The current spot exchange rate is $1.40/£, and the forward exchange rate is $1.35/£. The U.S. interest rate is 2.00%, and the U.K. interest rate is 4.00%. What will be the total dollar cost of this purchase in one year with money market hedge? Enter only the numeric portion of your answer.arrow_forwardBusco has a foreign-currency denominated payable, it can hedge by buying the foreign currency payable forward. The company can expect to eliminate the exposure without incurring costs as long as the forward exchange rate is an unbiased predictor of the future spot rate. Bus Co exported an A350 to a UK business, and was billed the sum of £11,000,000 payable in three months. Currently the spot rate is $1.30/£ and the three-month forward rate is $1.26/£.The three-month money market interest rate is 11% per annum in US and 7% per annum in UK.So the management of Busco decided to manage this transaction exposure and use the money market hedge to deal with this pound account payable. (i) Show how Busco can eliminate the exchange rate exposure by computing the dollar cost of meeting the pound obligation. ii)Conduct a cash flow analysis of the money market hedge.arrow_forward
- A friend of yours tells you that in Japan a specific Japanese treasury note matures for $1000 in two years can be bought or sold for $925. What is the annualized risk-free rate in this example? ) You happen to notice the same security can be purchased or sold domestically for $945, how do you arbitrage this position? How many times should you make this trade? How likely is it that your friend’s information is current and correct?arrow_forwardGamma airlines is currently considering a) to fix the price for their future jet fuel purchases and b) fixing the exchange rate for their future international receipts. As a financial advisor of the firm, you have advised them: for the first (a) to buy a future on crude oil (cross-hedging) For the latter (b) you suggest a currency future. Assuming Gamma Airline is a USA based firm, and it receives and pay in $. Explain to the board of directors using the above scenarios as an example that: What are the costs of making a futures contract in terms of the settlement, delivery for both events if the price fell below the agreed price and rise above the and who guarantees the fulfilment of contracts?arrow_forwardAn Omani importer will receive commodities from USA and he has to pay an amount of USD 250,000 next month. Which of the below markets is well suited to offer hedging protection against this transactions risk exposure? a. Inflation rate market O b. Transactions market C. Spot market O d. Forward marketarrow_forward
- Kansas Corporation, an American company, has a payment of €5.9 million due to Tuscany Corporation one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $ 6,555,556, but Kansas faces the risk that the €/S rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €5.9 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $109,000 for a one-year call option on €5.9 million at an exchange rate of 0.88 €/$. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount.arrow_forwardKansas Corp., an American company, has a payment of €5.3 million due to Tuscany Corp. one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $5,888,889, but Kansas faces the risk that the €/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €5.3 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $103,000 for a one-year call option on €5.3 million at an exchange rate of 0.88 €/$. a. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each strategy? (Round your answer to the nearest whole dollar amount.) Strategy 1 Strategy 2 Net Dollar Cost b. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each strategy? (Round your answer to the nearest whole…arrow_forwardA multinational corporation based in the United States expects to receive a large payment in euros from its European client in six months. The corporation wants to hedge against potential depreciation of the euro. Which specific forward contract(s) could the company use to mitigate the currency risk? Select all that apply: Buy U.S. dollars forward against euros Sell U.S. dollars forward against euros Buy euros forward against U.S. dollars Sell euros forward against U.S. dollarsarrow_forward
- Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
- Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage LearningCorporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education