If the distributor were to use a money market hedge what

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Reference no: EM13623825

A distributor has just purchased DM375,000 worth of fine German beer for the central Ohio market and must pay for the beer in 90 days. The distributor is concerned about changes in the value of the German mark during that period and has accumulated the following information.

Exchange Rates:

Today's spot exchange rate S0($/DM) = 0.5019/0.5240

Exchange rate available on 3 mo. future contracts F1/4($/DM) = 0.5028

The distributor's estimate of the spot exchange rate in 3 months S1/4($/DM) = 0.5050/0.5220

option information call option put option
contract size : DM62500 DM62500
Exercise price : $0.5050/DM $0.5090/DM
Premium : $0.0010/DM $0.0012/DM

Annual interest rate information US Rates(%) German Rates (%)

Invest: 5(US rate) 4(German rate)
Borrow : 8(US rate) 6(German rate)

a. If the distributor were to remain unhedged, how much would he expect to pay--in dollars--for the beer? Draw the payoff pattern.

b. If the distributor were to hedge this exposure with an option, which type of option would he use? Assuming that the distributor's estimate of the future spot rate is accurate, how many dollars would he pay for the beer?

c. If the distributor were to use a money market hedge, what would he expect to pay--in dollars--for the beer? (Use a diagram to explain your answer.)

d. Given your answers to the above questions, which would be the better way to hedge the distributor's currency risk?

Reference no: EM13623825

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