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FIN 444 Chapter 11 Math Solution

1. Pran needs to pay $1000 USD in 1 month and has several hedging strategies to deal with exchange rate risk. The best strategy is a forward hedge which costs 85,000 BDT. Hedging is better than not hedging as the real cost of hedging payables is negative. 2. Pran expects to receive $1000 USD in 1 month and again has hedging strategies to consider. The best strategy is money market hedge which yields 86,650 BDT. Hedging is better than not hedging as the real cost of hedging receivables is negative.

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58 views4 pages

FIN 444 Chapter 11 Math Solution

1. Pran needs to pay $1000 USD in 1 month and has several hedging strategies to deal with exchange rate risk. The best strategy is a forward hedge which costs 85,000 BDT. Hedging is better than not hedging as the real cost of hedging payables is negative. 2. Pran expects to receive $1000 USD in 1 month and again has hedging strategies to consider. The best strategy is money market hedge which yields 86,650 BDT. Hedging is better than not hedging as the real cost of hedging receivables is negative.

Uploaded by

Ahmed Kabir Akib 1631712630
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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FIN 444

Chapter 11
Math Solutions

1. Pran is a Bangladesh based MNC that will need $1000 in 1 month. It can use any one of
the following strategies to deal with the exchange rate risk. Estimate the taka cash flows paid
as a result of using the following strategies:

a. Forward hedge
b. Money market hedge
c. Option hedge
d. Which strategy is the best hedging technique for Pran.
e. Compare the most appropriate hedge to an unhedged strategy and decide whether Pran
should hedge its payables or not.

Use the following information to compute your answer.

Spot rate Dollar 86 Taka


One month forward rate 85 Taka

One-month call option Exercise price = 84 Taka


Premium = 2 Taka
USD BDT
One-month interest rate* 3% 5%
Rate Probability
Forecasted spot rate of Dollar 82 Taka 20%
85 Taka 30%
87 Taka 50%

*Borrowing and Lending rates are same


Answer:
a. Cost of Forward Hedge= 1000*85=85000 Taka

b. Money Market Hedge


1. Dollars to be invested=1000/1.03=$970.87
2. Taka to be borrowed=970.87*86=83493.96 Taka
3. Taka to be repaid=83493.96*1.05=87668.66 Taka

c. Call Option Hedge


Scenario Forecasted Exercise Premium Total Price paid per Total Probabili Total Price
Spot Rate Option? unit including Price ty
premium paid for
1000
Dollars
1 82 No 2 84 84000 0.2 16800
2 85 Yes 2 86 86000 0.3 25800
3 87 Yes 2 86 86000 0.5 43000
85600

d. Forward Hedge is the best technique


e.

Scenario Forecasted Spot Total Price paid for Probability Total Price
Rate 1000 Dollars
1 82 82000 0.2 16400
2 85 85000 0.3 25500
3 87 87000 0.5 43500
85400

Real Cost of Hedging Payables=85000-85400=-400


As RCHP is negative, so Pran should hedge.
2. Pran is a Bangladesh based MNC that is expecting to receive $1000 in 1 month. It can use
any one of the following strategies to deal with the exchange rate risk. Estimate the taka cash
flows received as a result of using the following strategies:

a. Forward hedge
b. Money market hedge
c. Option hedge
d. Which strategy is the best hedging technique for Pran.
e. Compare the most appropriate hedge to an unhedged strategy and decide whether Pran
should hedge its payables or not.

Use the following information to compute your answer.

Spot rate Dollar 85 Taka


One month forward rate 84 Taka

One-month put option Exercise price = 85 Taka


Premium = 1 Taka
USD BDT
One-month interest rate* 3% 5%
Rate Probability
Forecasted spot rate of Dollar 82 Taka 20%
84 Taka 30%
87 Taka 50%

*Borrowing and Lending rates are same

Answer:
a. Taka received from Forward Hedge= 1000*84=84000 Taka

b. Money Market Hedge


1. Dollars to be borrowed=1000/1.03=$970.87
2. Taka to be invested=970.87*85=82523.95 Taka
3. Taka to be received=82523.95*1.05=86650.15 Taka

c. Put Option Hedge


Scenario Forecasted Exercise Premium Total taka received Total Price Probability Total
Spot Rate Option? per unit after received for Price
premium 1000 Dollars
1 82 Yes 1 84 84000 0.2 16800
2 84 Yes 1 84 84000 0.3 25200
3 87 No 1 86 86000 0.5 43000
85000

d. Money Market Hedge is the best technique


e.

Scenario Forecasted Spot Total Price received Probability Total Price


Rate for 1000 Dollars
1 82 82000 0.2 16400
2 84 84000 0.3 25200
3 87 87000 0.5 43500
85100

Real Cost of Hedging Receivables=85100-86650.15=-1550.15


As RCHR is negative, so Pran should hedge.

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