Finance 475

Problem Set #9

1)      Suppose that you are expecting revenues of Y 100,000 from Japan in one month.  Currently, 1 month forward contracts are trading at $1 = $105 Yen.  You have the following estimate of the Yen/$ exchange rate in one month.

Price

Probability

90 Yen/$

2%

95 Yen/$

25%

100 Y/$

45%

105 Yen/$

20%

110 Yen/$

8%

a)      What position in forward contracts would you take to hedge your exchange risk?

b)      Calculate the expected value of the hedge.

c)      How could you replicate this hedge in the money market?

2)      You are expecting a wage bill denominated in British pounds in 3 months.  You want to hedge your risk of a dollar depreciation, but would also like to capitalize off the possibility of a dollar appreciation. You are considering two strategies:

a)      Purchasing a call option on British pounds with a strike price of $1.80.  The premium on this option is $.04 per pound. 

b)      Hedging only 1/3 of the cost with a forward contract (forward price = $1.80)

Within what range for the future exchange rate would the partial hedge outperform the option hedge?

3)      What is a straddle hedge and why would it be useful?

4)      You have a payment due one month from now denominated in Mexican Pesos. The Peso is currently trading at $1 = MXP 11, but you worry about an appreciation of the Peso.  Your forecast suggests a 95% confidence interval of      [10, 8] pesos per dollar.  How could you hedge this range only?

5)      You have a payment due in Euros.  Currently, the Euro is trading at $1.35, but you want to hedge your risk by buying a call option with a strike price of $1.35.  If the premium on the option is $.06 per Euro, how high would the exchange rate have to go before the option become valuable?