Reference no: EM133069082
1. Larkin Hydraulics, a wholly owned subsidiary of Caterpillar (U.S.), sold a 12 megawatt compression turbine to Rebecke-Terwilleger Company of the Netherlands for €4,000,000, payable in three months (90 days). Larkin derived its price quote of €4,000,000 by dividing its normal U.S. dollar sales price of $4.320,000 by the then current spot rate of $1.0800/€.
Four approaches are possible:
1. Hedge in the forward market. The 3-month forward exchange quote was $1.1060/€.
2. Hedge in the money market. Larkin could borrow euros in the Libor market at 8% per annum and invest in € at 5% p.a. In the USD Libor market the firm can borrow at 7% p.a. and invest at 4% p.a.
3. Hedge with foreign currency options. 90 day put options are available at strike price of $1.1000/€ for a premium of 2.0% per contract. 90 day call options with a strike at $1.1000/€ could be purchased for a premium of 3.0%.
4. Do nothing. Larkin could wait until the sales proceeds were received in August and sell the euros received for dollars in the spot market.
Larkin's banker forecasts that the exchange rate in 90 days will be $1.1400/€.
What should Larkin do?