Reference no: EM133111294

Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for €1,250,000.  The sale was made in June with payment due six months later in December.  Because this is a sizable contract for the firm and because the contract is in Euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale.  To help the firm make a hedging decision you have gathered the following information.

• The spot exchange rate is $1.40/€
• The six month forward rate is $1.38/€
• Plains States' cost of capital is 11%
• The Euro zone borrowing rate is 9% per annum (or 4.5% for 6 months)
• The Euro zone lending rate is 7% per annum (or 3.5% for 6 months)
• The U.S. borrowing rate is 8% per annum (or 4% for 6 months)
• The U.S. lending rate is 6% per annum (or 3% for 6 months)
• December put options for €625,000; strike price $.1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/€
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/€

1. If Plains States chooses not to hedge their euro receivable, the amount they receive in six months will be _____________.

a. $1,250,500

b. $892,857

c. none of the choices is correct

d. undeterminable today

e. $1,750,000

2. If Plains States chooses to hedge its transaction exposure in the forward market, it will __________ €1,250,000 forward at a rate of ___________.

a. sell; $1.38/€

b. buy; $1.40/€

c. buy; $1.38/€

d. none of the choices is correct

e.sell; $1.40/€