Description
Maria possesses £1,000,000 for three months and seeks to identify the most effective strategy to hedge her foreign exchange exposure. She is evaluating four possible approaches:
Unhedged
Option Hedge
Money Market Hedge
Forward Hedge.
Based on her financial objectives and market conditions, which hedging method should Maria select, and what are the key reasons supporting this choice?
Please provide the description, highest and lowest profit, risk level, and advantages and disadvantages for each strategy
effective strategy to hedge her foreign exchange exposure. She is evaluating four
possible approaches: Unhedged Option Hedge Money Market Hedge Forward
Hedge.
Based on her financial objectives and market conditions, which hedging method
should Maria select, and what are the key reasons supporting this choice? Please
provide the description, highest and lowest profit, risk level, and advantages and
disadvantages for each strategy
1
Trident’s Transaction Exposure
• Maria Gonzalez, CFO of Trident, has just
concluded a sale to Regency, a British firm,
for £1,000,000
• The sale is made in March for settlement
due in three months time, June
– Assumptions
• Spot rate is $1.7640/£
• 3 month forward rate is $1.7540/£ (a 2.2676%
discount)
• Trident’s cost of capital is 12.0%
• UK 3 month borrowing rate is 10.0% p.a.
• UK 3 month investing rate is 8.0% p.a.
10-21
© 2012 Pearson Education, Inc. All rights reserved.
Trident’s Transaction Exposure
– Assumptions
• US 3 month borrowing rate is 8.0% p.a.
• US 3 month investing rate is 6.0% p.a.
• June put option in OTC market for £1,000,000;
strike price $1.75; 1.5% premium
• Trident’s foreign exchange advisory service
forecasts future spot rate in 3 months to be
$1.7600/£
• Trident operates on thin margins and Maria
wants to secure the most amount of US
dollars; her budget rate (lowest acceptable
amount) is $1.7000/£
10-22
© 2012 Pearson Education, Inc. All rights reserved.
Exhibit 10.4 Trident’s Transaction
Exposure
10-23
© 2012 Pearson Education, Inc. All rights reserved.
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