Costs of hedging by forward contracts and option contract

Assignment Help Financial Management

Reference no: EM132052758

Question A :

Alcoa Chemical, a US company, has sold £2 million chemicals to CPL Co. Payment is due in 180 days.

Spot rate: $1.60/£

180-day forward rate $1.56/£

180-day U.S. dollar interest rate (annualized) 3%

180-day Pound interest rate (annualized) 4%

180-day call option on pound at $1.57/£ premium $0.06 per pound

180-day put option on pound at $1.57/£ premium $0.05 per pound

(a) What is the hedged value of Alcoa's receivable using the forward market hedge?

(b) What is the hedged value of Alcoa's receivable using the money market hedge?

(d) What alternative is available to Alcoa to use currency options to hedge its receivable? What is the hedged value of Alcoa's receivable using the option hedge?

(e) Discuss and compare the costs of hedging by forward contracts and option contracts.

(Numbers should be rounded to at least 3 decimal places. Please include currency symbols $, £ in your answer)

Question B:

Mill Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $150,000, and has a terminal value of $20,000. The company's cost of capital is 8%. The project has a life-time of 3 years. The operating cash flows are as follows:

Year 1 Year 2 Year 3

1. After-tax savings $35,000 $35,000 $35,000

2. Depreciation tax savings $22,500 $25,000 $8,000

Net cash flow $57,500 $55,000 $43,000

(a) Find the net present value of this project (NPV). Should it be accepted?

Suppose Mill Company wishes to expand its operations in the UK. The exchange rate at the time of investment is £1= $1.60.

(b) Use the PPP to find the exchange rate 1 year from now, 2 years from now and 3 years from now. The inflation rate in the U.S. (?$) is 3 percent and in the UK 5 percent (?£)

(Numbers should be rounded to at least 3 decimal places. Please include currency symbols $, £ in your answer)

Reference no: EM132052758

Questions Cloud

Firm can pay for project and still earn its required return : The firm's D/E ratio is 1.2. What is the most the firm can pay for the project and still earn its required return?

Company earnings per share : A manager manipulates accounting numbers to improve her company’s earnings per share (EPS) in the second quarter of 2016 (2016Q2).

The proportion of municipal bonds in his portfolio : Isaac received a promotion, which includes a permanent raise. How should he change the proportion of municipal bonds in his portfolio?

How does times interest ratio affect tech company : How does times interest ratio affect a tech company? And if their tie ratio is around 13, what does that mean?

Costs of hedging by forward contracts and option contract : What is the hedged value of Alcoa's receivable using the forward market hedge? Discuss and compare costs of hedging by forward contracts and option contract.

Portfolio equally invested in risk-free asset and two stock : You own a portfolio equally invested in a risk-free asset and two stocks. What must the beta be for the other stock in your portfolio?

Company need to support this year projected sales : What amount of additional funds does the company need to support this year’s projected sales?

The impact of personal data protection act : what are the impact of Personal Data Protection Act 2010 on banking industry? Give ways on how to manage the impact.

Require effective annual interest rate : If you require an "effective" annual interest rate (not a nominal rate) of 11.95%, how much should you be willing to pay for the bond?

User Account

All Pages