week7_Chapter 8 Case Study Answer

week7_Chapter 8 Case Study Answer - Chapter 8 the rationale...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 8 the rationale for hedging currency risk: case study Suppose a US firm only invests in a project in the UK. The firm value is equal to the project’s payoff in a year. To finance its initial investment in the UK, it borrows both from shareholders and bondholders in the US. One year later, the promised payment to bondholders is $1,000, and the rest will be paid to shareholders. The expected payoff of this project is £1,000. The exchange rate between US dollars and British pounds is very volatile. It could be either $0.75/£ or $1.75/£ in a year (each is in 50% chance). If the firm does not have enough money to pay bondholders in a year, this firm needs to file for bankruptcy. The one-year ahead forward rate is $1.25/£. (1) Should this firm hedge or not hedge against currency risk? Calculate expected payoffs from perspectives of bondholders, shareholders, and firm under hedging or non hedging decision. Choice : do not hedge against currency risk Firm Good scenario payoff=£1,000*$1.75/£=$1,750 Bad scenario payoff=£1,000*$0.75/£=$750 Expected
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 03/25/2012 for the course FINS 3616 taught by Professor Curry during the Three '10 term at University of New South Wales.

Page1 / 3

week7_Chapter 8 Case Study Answer - Chapter 8 the rationale...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online