Indifferent between the option and forward hedge

Assignment Help Financial Management

Reference no: EM132021042

UA purchased an aircraft from Airbus and was billed €30 million payable in one year. UA is concerned with the USD costs from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and one-year forward exchange rate is $1.10/€ at the moment. UA can buy a one-year option on euro with a strike price of $1.12/€ for a premium of $0.02 per euro. Currently, the annual interest rate is 5% in the euro zone and 6% in the U.S.

This is an (select Accounts Receivable or Payable) case for UA. If UA wants to hedge the transaction exposure using forward, UA should enter a (Long/Short) position in a forward contract of €30 million due in one year.

If UA enters a forward euro contract today, the guaranteed dollar cost for this euro obligation in one year should be XXX$ million. If UA wants to hedge the transaction exposure using money market hedge, UA should ______________. borrow PV of euro and buy USD today, and deposit USD in the bank and sit on it. buy PV of euro today using USD, and deposit euro in the bank and sit on it. If UA uses MMH, the guaranteed dollar cost today should be $ million If UA wants to hedge the transaction exposure using option hedge, UA should ______________. (buy a put option sell a put option buy a call option sell a call option)

If UA hedges the exposure using an option hedge, total option premium: $XXXXX million will be paid today. The option premium will grow to $ million in one year at the US interest rate. In one year, if the spot price is $1.1 per euro, the option is (in/out) of the money. So, UA will buy 30 million euro at the price of $XXXX per euro, which equals to a total cost of $XXXX million. After the option premium, the total (net) dollar costs in one year is $XXXX million. At what future spot exchange rate do you think UA will be indifferent between the option and forward hedge? Answer: $ /€.

Reference no: EM132021042

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