Reference no: EM133032350

Question - Airbus has a foreign-currency denominated payable, it can hedge by buying the foreign currency payable forward. The company can expect to eliminate the exposure without incurring costs as long as the forward exchange rate is an unbiased predictor of the future spot rate. Airbus exported an A380 to a UK company, and was billed the sum of £ 12,000,000 payable in three months.

Currently the spot rate is $1.40/£ and the three-month forward rate is $1.36/£. The three-month money market interest rate is 12% per annum in US and 8% per annum in UK. So the management of Airbus decided to manage this transaction exposure and use the money market hedge to deal with this pound account payable.

(i) Explain how Airbus can eliminate the exchange rate exposure and compute the dollar cost of meeting the pound obligation.

(ii) Conduct a cash flow analysis of the money market hedge.

(iii) Compare and contrast the cash flow at maturity and the net dollar proceeds if instead the options market hedge is used by Airbus. You may assume a put option of £ 12,000,000 with an exercise price of $1.36/£ with a three-month expiration and an option premium of $ 0.05 per £.