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TUTORIAL 10-IF

# TUTORIAL 10-IF - TUTORIAL 10 TOPIC 9 MANAGING EXPOSURE...

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Click to edit Master subtitle style 4/12/11 TUTORIAL 10 TOPIC 9 MANAGING EXPOSURE

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4/12/11 Q1. Pallister Ltd is a British importer of chips. The company has contracted to purchase 5,000 units of chips at a unit price of 30 Swiss Franc from one Swiss company. Three month’s credit is allowed to Pallister Ltd before payment is due. Pallister Ltd currently has no cash surplus, but can borrow short term at 2% above bank base rate or invest Exchange rates Swiss franc/Pound Spot 2.990-3.020 1 month forward 2.975-3.005 3 months forward 2.945-2.965 Current Bank Base rates 6% per annum 10% per annum Pallister Ltd has a 3-month call option on Swiss Franc at an exercise price of 2.930 Swiss Franc per Pound with 1% premium and a 3-month put option on Swiss Franc at an exercise price of 2.930 Swiss Franc per Pound with a 2.5% premium. Assume Pallister’s cost of capital is 10%. Calculate the cost of hedging using: a) Forward market hedge b) Money market hedge c) Option hedge
4/12/11 Q1. Calculate the cost of hedging using: a) Forward market hedge It is an account payable of SF150 000 (5000 units x SF30 due in 3 months. Pallister SF forward at SF 2.945/£

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4/12/11 b) Money market hedge Step 1: Lend SF 150 000/ [ 1+ (0.06/4)] = SF 147 783.25 today. Step 2: Borrow £ today and immediately convert it into SF to invest in Switzerland. Sell £ to invest SF in the
4/12/11 Borrow at 12% p.a. Exchange at Effective exchange rate SF 2.990/£ SF150000/£50908.62 = SF 2.9464/£ 2. Borrow £ 49425.84 3.Pays £ 50908.62 2.Invest SF 147783.25 1. Receives SF 150000

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4/12/11 c) Option hedge Pallister Ltd has an account payable in Swiss Franc, he should buy a call option because Pallister needs to purchase the right to buy to pay account payable. Premium cost paid to purchase a call option on SF [SF 150000 x 1%]/SF2.990/£= £501.67
4/12/11 d) Which is the best alternative? The best alternatives is money market

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TUTORIAL 10-IF - TUTORIAL 10 TOPIC 9 MANAGING EXPOSURE...

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