Reference no: EM132740207
Central Valley Transit Inc. (CVT) has just signed a contract to sell light rail cars to a retailer in Germany for euro 3,000,000. The purchase 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, CVT 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 $1.250/euro
The six-month forward rate is $1.22/euro
CVT's cost of capital is 11%
The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
The U.S. 6-month lending rate is 6% (or 3% for 6 months)
December call options for euro 750,000; strike price $1.28, premium price is 1.5%
CVT's forecast for 6-month spot rates is $1.27/euro
The budget rate, or the highest acceptable purchase price for this project, is $3,900,000 or $1.30/euro
If CVT chooses NOT to hedge their euro receivable, the amount they pay in six months will be:
Which of the following is the answer?
$3,500,000
-unknown today
-$3,900,000
-€3,000,000
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