Reference no: EM133068042
P&G Limited considers hedging its receivables of €500000 due in 4 months. It can obtain a forward contract to purchase Euro in 4 months. The forward rate of the Euro for the same period is $1.25, the same rate as currency futures contracts on Euros.
As a second alternative, P&G Limited can use the money market to hedge its receivables. The spot rate of Euro is $1.15 today. Moreover, the European money market interest rate is 5% for 4 months while the money market interest rate for the same period is 6% in the USA.
As a third alternative, the company can hedge its receivables with a currency option. A suitable option with an exercise price of $1.24, a premium of $0.03, and an expiration date of 4 months from now is available. Assume that P&G's forecasts for the spot rate of the Euro at the time payments are due are as follows:
-$1.20 (20% probability)
-$1.23 (30% probability)
-$1.26 (30% probability)
-$1.28 (20% probability)
Finally, the company may apply a strategy for hedging its receivables which are known as wait-and-see. Thus, they can choose to sit idle and do nothing i.e., employing the non-hedge alternatives, as well. Based on the above information regarding hedging alternatives:
-Determine the cash flow under different hedging alternatives.
-How much the company should be receiving under the "wait-and-see" strategy?
-What is the real cost of hedging under different hedging alternatives? Which hedging alternative should be exercised? Explain why?
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: P&G Limited considers hedging its receivables of €500000 due in 4 months. It can obtain a forward contract to purchase Euro in 4 months.
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