Reference no: EM132719517
On May 1, Larkin Hydraullics, 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 as €2,000,000 on August 1 and €2,000,000 on November 1. Larkin derived its price quote of €4,000,000 on April 1 by dividing its normal U.S. dollar sales price on $4,320,000 by the current spot rate of $1.0800/ €.
By the time the order was received and booked on May 1st oh, the Euro had strengthened to $1.1/€ so the sale was in fact worth €4,000,000 X $1.1/€ = $4,400,000. Larkin had already gained an extra $80,000 from favorable exchange rate movements. Nevertheless, Larkins Director of Finance now wondered if the firm should hedge against the reversal of the recent trend of the euro.... What should they do deciding with the 4 options:
-Cost of equity: 12% per annum
-US Tbill: 3.6% per annum
1: Hedging in the forward market: the 3 month forward of $1.1060/€. And the 6 month forward of 1.113/€.
2: Hedging in money market: Larkin could borrow Euros from the Frankfurt branch of US bank at 8% per annum
3: Hedge with foreign currency options: August put options were available at strike price of $1.1/€ for a premium of 2% per contract and November put at $1.1/€ for a premium of 1.2%.
August call at $1.1/€ and premium of 3% and November call at $1.1/€ at 2.6% premium
4. Do nothing.
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: On May 1, Larkin Hydraullics, a wholly owned subsidiary of Caterpillar (U.S) sold a 12- megawatt compression turbine to Rebecke- Terwilleger company
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