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Compare hedging alternatives and make a recommendation

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Question - Dragon Inc, of Moorhead purchased a Korean company that produces plastic nuts and bolts for auto manufacturers. The purchase price was Won7,030 million. Won1,000 million has already been paid and the remaining Won6,030 million is due in six months. The current spot rate is Won1,200/$, and the 6-month forward rate is Won1,260/$

Additional data:

a. Six-month Korean interest rate: 16.00% p.a.

b. Six-month US interest rate: 4.00% p.a.

c. Six-month call option on Korean Won at 1,260 with a premium of Won33.33/$

d. Six-month put option on Korean Won at 1200 with a premium of Won41.67/$

e. Dragon can invest at the rates given above or borrow at 2% p.a. above those rates. Dragon's cost of capital is 25%.

f. Assume any new proceeds are invested in T-bills (not used to replace borrowings nor invested in the firm's tangible assets)

g. Any new funds can be raised at the borrowing rate. Option premium is also financed using borrowings.

Required - Compare hedging alternatives and make a recommendation.

Reference no: EM132858475

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