Cost of call option hedge for euro receivable contract

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Reference no: EM131512390

Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 3,000,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

· The spot exchange rate is $1.250/euro

· The six month forward rate is $1.22/euro

· CVT's cost of capital is 11%

· The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)

· The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)

· The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)

· The U.S. 6-month lending rate is 6% (or 3% for 6 months)

· December call options for euro 750,000; strike price $1.28, premium price is 1.5%

· CVT's forecast for 6-month spot rates is $1.27/euro

· The budget rate, or the highest acceptable purchase price for this project, is $3,900,000 or $1.30/euro

1) CVT would be ________ by an amount equal to ________ with a forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had been correct. A) better off; $150,000 B) better off; €150,000 C) worse off; $150,000 D) worse off; €150,000

2) What is the cost of a call option hedge for CVT's euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.) A) $57,600 B) $59,904 C) $62,208 D) $63,936

3) The cost of a put option to CVT would be: A) $52,500. B) $55,388. C) $58,275. D) There is not enough information to answer this question.

Reference no: EM131512390

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