Dr2_lecture - Example of hedging with forwards or options FNCE102 R Loh Derivatives 2 Week 13 Hedging with futures and options Interest Rate

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FNCE102 R. Loh: Derivatives 2 Week 13 Hedging with futures and options Interest Rate Derivatives 2/19 Roger Loh Example of hedging with forwards or options ± Cadillac exports cars to a Portuguese car dealer for a total of €1 million. This amount will be received in six months. ± Cadillac is exposed to fluctuations in the EUR exchange rate during the next six months. The future USD revenues from this sale are uncertain. ± Qn, is Cadillac’s underlying position long or short Euro? Answer ____________ . ± The interest rates and and foreign exchange rates are: 1.3127 F 6-month 1.30 Spot (USD/EUR) 4% p.a. r 6% p.a. r $ 3/19 Roger Loh Underlying position of Cadillac Underlying position S 6 (USD/EUR) 1.3127 Proceeds $1,312,700 4/19 Roger Loh Forward or futures hedge ± Cadillac can hedge its exposure by selling its € denominated receivables in the forward market. ± Cadillac will sell €1,000,000 @ the 6-month forward rate ($1.3127/€). Cadillac is thus guaranteed to receive $1,312,700 in six months, regardless of the spot exchange rate in six months. ± This hedge completely eliminates foreign exchange exposure. { If the € appreciated against the US $, Cadillac would benefit. Yet, by entering into either the forward or money market hedge, Cadillac gives up this potential upside. Of course, they are protected against a depreciation of the €. ± Is there a hedge in which Cadillac can retain some of the upside potential, while limiting its downside risk?
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5/19 Roger Loh Forward and Money Market Hedges ± Both types of hedges completely eliminate foreign exchange exposure. ± In the Cadillac example, if the € would have appreciated against the US $, Cadillac would benefit if the did not hedge. Yet, by entering into either the forward hedge, Cadillac gives up this potential upside. Of course, they are protected against a depreciation of the €. ± Is there a hedge in which Cadillac can retain some of
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This note was uploaded on 06/06/2009 for the course SOB FNCE102 taught by Professor Rogerloh during the Spring '09 term at Singapore Management.

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Dr2_lecture - Example of hedging with forwards or options FNCE102 R Loh Derivatives 2 Week 13 Hedging with futures and options Interest Rate

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