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536-4a_note[1] - 536-4a_note, 11S FIN 536 SU Page 1 of 16...

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Unformatted text preview: 536-4a_note, 11S FIN 536 SU Page 1 of 16 Topic 4 Managing Transaction Exposure (Chapter 11) I.Outline A.Identify Transaction Exposure B.Measure Transaction Exposure C.Manage Transaction Exposure II.Homework Assignment Chapter11End-of-Chapter Question2End-of-Chapter Problem (P)14Exam Sample Problem (ES) 1-11 Supplementary Homework Problem (SH)1-5========================================================= Class Notes I.Introduction A.Types of Foreign Exchange Exposure (Ex. 11.1) B.The value of hedging (Ex. 11.2) 1.Reduces risk 2.Do not add value C.To hedge or not to hedge? Opponents for currency hedging Proponents for currency hedging No added value Planning capability Shareholder to diversify risk Financial distress Agency problem, window dressing Insider information Market equilibrium Market disequilibrium Efficient market Inefficient market 536-4a_note, 11S FIN 536 SU Page 2 of 16 II.Measure Transaction Exposure A.Purchasing or selling on open account (Ex. 11.3) B.Borrowing and lending C.Example P11.14 III.Manage Transaction Exposure A.Contractual hedges: Forward, Money market, Futures, and Options B.Operating hedges (natural hedges): Risk sharing, Leads and lags in the payment terms, etc.. C.Financial hedges: Debt, Interest rate swap, currency swap 02/01 03/01 06/01 08/01 09/01536-4a_note, 11S FIN 536 SU Page 3 of 16 IV.Contractual Hedge A.The case of Trident AR exposure A US firm, Trident, sells communication equipment to Regency, a British firm, in March for 1 million. Payment is due three months later, in June. You are asked to evaluate the following different hedging alternatives. Assume cost of capital = WACC. Strategy A: Remain unhedged Strategy B: Forward (Future) hedge Strategy C: Money market hedge Strategy D: Option hedge. (Use WACC to calculate FV) Strategy E: Range Forward hedge Strategy F: Synthetic Forward hedge Strategy G: Participating Forward hedge The following information is available: FX market S = 1.7640 $/, F3= 1.7500 $/, E(S3) = 1.76 $/ Money market 3-month Borrowing: r= 10%, r$= 8% 3-month Deposit: r= 8%, r$= 6% Option market June Call on : K=1.71 $/, C=3.2230% K=1.75 $/, C=1.5000% K=1.78 $/, C=1.1000% June Put on : K=1.71 $/, P=1.0000% K=1.75 $/, P=1.5000% K=1.78 $/, P=2.7673% WACC 12% 1.Prepare the required market data for analysis FX market S = 1.7640 $/, F3= 1.7500 $/, E(S3) = 1.76 $/ Money market 3-month Borrowing: r= %, r$= % (per quarter) 3-month Deposit: r= %, r$= % (per quarter) Option market June Call on : K=1.71 $/, C= $/ K=1.75 $/, C= $/ K=1.78 $/, C= $/ June Put on : K=1.71 $/, P= $/ K=1.75 $/, P= $/ K=1.78 $/, P= $/ WACC % (per quarter) 536-4a_note, 11S FIN 536 SU Page 4 of 16 2.Strategy A: Remain unhedged....
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