Compute the future Euro cash flow

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Reference no: EM132810729

Question - Veljko's Pizzeria, based in Italy, buys furniture from a store in Switzerland, to be paid in one year in Swiss Franc (SF). Accordingly, Veljko's Pizzeria owes SF50,000 in one year. The current spot rate is €1.3/SF and the one-year forward rate is also €1.3/SF per yen. The annual interest rate is 2% in Italy and 3% in Switzerland. Veljko's Pizzeria can also buy:

- a one-year call option on SF at the strike of €1.25 per SF for a premium of €0.025 per 1SF;

- a one-year put option on yen at the strike of €1.15 per SF for a premium of €0.025 per 1SF;

(a) Compute the future Euro cash flow using the forward hedge.

(b) Assuming Veljko's Pizzeria wants to hedge with options, what does it need (puts or calls on SF)?

(c) Assume that Veljko's Pizzeria has borrowed to pay for the option. Assuming that that the spot rate at expiration is €1.2/SF, compute the future Euro cash flow under the option-hedging strategy.

(d) Is there any spot rate at expiration that will make Veljko's Pizzeria indifferent between the option and forward hedge? Explain and compute, as necessary.

(e) Compute the payables under the money market hedge.

(f) Which hedging method would you prefer? What is your maximum Euro payable?

Reference no: EM132810729

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