Reference no: EM133085643

Question - Let's say you are a representative of an Estonian company that buys wild mushrooms harvested in the forests of Võrumaa and exports them to England. Under the supply contract, you undertake to deliver 50 tonnes of mushrooms at a price of GBP 4 per kilogram after one year. Let's say you pay mushrooms for 3.80 euros per kilo. Assume that the cash flows related to the performance of the contract will all take place in exactly one year.

a) Describe the currency risk in this example and why would the company want to hedge it? Is risk mitigation essential?

b) Assume that you do not hedge the currency risk. Describe on the graph (incl. Mark the axes) what your profit will be or in euros (be here regularly!) If the exchange rate can fluctuate from 0.80 to 1.20 EUR / GBP (for example, in increments of 0.10 euros).

c) Assume that the current forward rate is EUR / GBP 0.90. What do you do with an employment contract to hedge currency risk with a forward? Show the result (profit or loss) on the graph. What is your expected profit from the transaction?

d) Now assume that you can enter into an option agreement to sell the pounds against the euro at a transaction price of 0.90 EUR / GBP. The premium for a one-year contract is £ 0.10 per pound. Also indicate hedging performance options.

e) If the company decides to hedge the risk, when could it be decided to proceed, in favor of the option?