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Tutorial+20+Solution - BUS3026W Finance II 2009 Tutorial 20...

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1 BUS3026W Finance II 2009 - Tutorial 20 Suggested Solution Due: Monday 19 th October 09 QUESTION 1 a. The implied exercise (price) rate is: 10,000/15,000 = $0.6667/SF . b. If the Swiss client chooses to pay $10,000, it will cost SF16,129 (=10,000/.62) . Since the Swiss client has an option to pay SF15,000, it will choose to do so. The value of this option is obviously SF1,129 (=SF16,129- SF15,000). c. Baltimore Machinery faces a contingent exposure in the sense that it may or may not receive SF15,000 in the future. The firm thus can hedge this exposure by buying a put option on SF15,000. [2, 2, 2] QUESTION 2 Cross-hedging involves hedging a position in one asset by taking a position in another asset. The effectiveness of cross-hedging would depend on the strength and stability of the relationship between the two assets. [3] QUESTION 3 a. Economic exposure can be defined as the sensitivity of the future home currency value of the firm s assets and liabilities and the firm s operating cash flow to random changes in exchange rates. b. The competitive effect: exchange rate changes may affect operating cash flows by altering the firm’s competitive position. The conversion effect: A given operating cash flows in terms of a foreign currency will be converted into higher or lower dollar (home currency)amounts as the exchange rate changes. c. Possible measures that GM can take include: (1) diversify the market; try to market the cars not just in Spain and other European countries but also in, say, Asia; (2) locate production facilities in Spain and source inputs locally; (3) locate production facilities, say, in Mexico where production costs are low and export to Spain from Mexico.
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