Finance case questions

I have sent 2 Question. I have answered most of the questions. Please look over my work and answer the final part of the question in the answer attachment.

Try your answers on your own and THEN try to see what I could be doing wrong. Please provide a detailed response.

Question 6 (Futures):

Packers Inc. is a U.S. based manufacturer of cheese. The company

considers expanding its current operations by building a plant in the

U.K. The CFO has presented the board with the following cash flow

projections:

Required initial outlay in U.S. dollars to be paid immediately is

$600,000. The projected cash flows in British pounds due in exactly six

months are GBP 500,000.

The CFO informs the board that the U.S. risk-free rate is 5.5% (APR)

while the U.K risk free rate is 7.2% (APR). The current spot exchange

rate is 1.62 $/GBP (that is, 1.62 dollars buy 1 British pound). The

futures price of the pound, for delivery in six months, is 1.61 $/GBP.

The CFO assumes that the project is riskless and that given her

calculations the firm ought to invest in the new plant.

Assume that interest is compounded semi-annually. Ignore the fact that

futures are marked to market and assume that all cash flows connected

with the futures contract occur at the maturity of the contract.

Should the company undertake this project given the above assumptions?

Answer: Yes

Your reasoning:

Cost of project = $600,000

Revenue from project = Ð500,000*1.61 = $805,000

Present value of Revenue = $783,455

Profit from project = $783,455 - $600,000 = $183,455

Recommendation = Yes

Assume that the CFO can use foreign currency futures contracts on the

British Pound. Specifically, she can buy or sell 62,500 pounds per

contract for delivery in six months from today. Should she purchase or

sell such contracts if she wants to receive U.S. dollars in exactly six

months? Specify in your answer the number of contracts.

Answer: _8 contracts

Your reasoning:

The CFO should sell GBP futures contract to receive USD in six months

time.

Ð500,000 worth of contracts at Ð62,500 each

each contract = $ 100,625

500,000 / 62500 = 8 contracts

total = $805,000

Demonstrate that the hedge in b) works by showing that a fall of the

pound to $1.55 or an increase in the pound to $1.65 do not affect the

total dollar value of the cash inflow of GBP 500,000.

Your reasoning:

Cost of Ð on delivery date = 1.55 $/Ð 62,500*8*1.55 = $ 775,000

Cumulative futures gain per Ð = 0.6 $/Ð 62,500*8*0.06 = $

30,000

Net cost of Ð

1.61 $/Ð

$ 805,000

Cost of Ð on delivery date = 1.65 $/Ð 62,500*8*1.65 = $ 825,000

Cumulative futures loss per Ð = 0.4 $/Ð 62,500*8*0.04 $ (20,000)

Net cost of Ð

1.61 $/Ð

$ 805,000

( If six-month futures contracts are not available, can the CFO assure

the board that she will be able to lock in the rate for exchanging the

500,000 pounds into dollars six months from today? If so, outline what

are the transactions that she needs to undertake in order to guarantee

this rate.

Your reasoning:

Question2 (Options):

In February you observe that XYZâs stock price is $103. The March call

option with exercise price $100 will expire in exactly one month and is

trading at $5. The March put option with exercise price of $100 is

trading at $1.50. Assume that the interest rate is 6% p.a. (continuously

compounded) and that XYZ will not pay dividends over the next month.

Calculate the payoffs for an investor who has bought one call option by

completing the table below. Draw the payoff diagram. Do not include the

initial option premium in your payoffs.

Stock Price 80 100 120 140

Payoff 0 0 20 80

Your reasoning:

Payoff

0

$100

Stock Price ST

Calculate the payoffs for an investor who has bought one XYZ share and

one put option by completing the table below. Draw the payoff diagram.

Do not include the initial option premium in your payoffs.

Stock Price 80 100 120 140

Payoff -3 -3 17 37

Your reasoning:

Payoff

$100

$100

Stock Price ST

( A friend of yours wants to purchase a futures contract on XYZ.

Unfortunately, no such contract is available and he asks for your help.

You can only buy (or sell) the above call and put options as well as buy

(or sell) bonds. Can you replicate the cash flows of the futures

contract with these options and bond? How much would your friend have to

pay today in order to set up this replication? What is the implied

futures price?

Your reasoning:

Question 1 (Futures):

Packers Inc. is a U.S. based manufacturer of cheese. The company

considers expanding its current operations by building a plant in the

U.K. The CFO has presented the board with the following cash flow

projections:

Required initial outlay in U.S. dollars to be paid immediately is

$600,000. The projected cash flows in British pounds due in exactly six

months are GBP 500,000.

The CFO informs the board that the U.S. risk-free rate is 5.5% (APR)

while the U.K risk free rate is 7.2% (APR). The current spot exchange

rate is 1.62 $/GBP (that is, 1.62 dollars buy 1 British pound). The

futures price of the pound, for delivery in six months, is 1.61 $/GBP.

The CFO assumes that the project is riskless and that given her

calculations the firm ought to invest in the new plant.

Assume that interest is compounded semi-annually. Ignore the fact that

futures are marked to market and assume that all cash flows connected

with the futures contract occur at the maturity of the contract.

Should the company undertake this project given the above assumptions?

Answer: Yes/No (delete one)

Your reasoning:

Assume that the CFO can use foreign currency futures contracts on the

British Pound. Specifically, she can buy or sell 62,500 pounds per

contract for delivery in six months from today. Should she purchase or

sell such contracts if she wants to receive U.S. dollars in exactly six

months? Specify in your answer the number of contracts.

Answer: _______

Your reasoning:

Demonstrate that the hedge in b) works by showing that a fall of the

pound to $1.55 or an increase in the pound to $1.65 do not affect the

total dollar value of the cash inflow of GBP 500,000.

Your reasoning:

( If six-month futures contracts are not available, can the CFO assure

the board that she will be able to lock in the rate for exchanging the

500,000 pounds into dollars six months from today? If so, outline what

are the transactions that she needs to undertake in order to guarantee

this rate.

Your reasoning:

Question 2 (Options):

In February you observe that XYZâs stock price is $103. The March call

option with exercise price $100 will expire in exactly one month and is

trading at $5. The March put option with exercise price of $100 is

trading at $1.50. Assume that the interest rate is 6% p.a. (continuously

compounded) and that XYZ will not pay dividends over the next month.

Calculate the payoffs for an investor who has bought one call option by

completing the table below. Draw the payoff diagram. Do not include the

initial option premium in your payoffs.

Stock Price 80 100 120 140

Payoff

Your reasoning:

Calculate the payoffs for an investor who has bought one XYZ share and

one put option by completing the table below. Draw the payoff diagram.

Do not include the initial option premium in your payoffs.

Stock Price 80 100 120 140

Payoff

Your reasoning:

( A friend of yours wants to purchase a futures contract on XYZ.

Unfortunately, no such contract is available and he asks for your help.

You can only buy (or sell) the above call and put options as well as buy

(or sell) bonds. Can you replicate the cash flows of the futures

contract with these options and bond? How much would your friend have to

pay today in order to set up this replication? What is the implied

futures price?

Your reasoning:

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