Strongly expect the euro to depreciate

Assignment Help Financial Management

Reference no: EM131921102

American Airlines has just signed a contract to purchase an A340-600 aircraft from Airbus for 250,000,000 euros. The payment is due six months later. As the Lead Risk Analyst of American Airlines, you are considering how best to hedge the exchange rate risk arising from the purchase, and need to make a recommendation to the Treasurer based on your analysis. You have gathered the following information:

The spot exchange rate is $1.2000/€

The six month forward rate is $1.1950/€

The cost of capital of American Airlines is 12% per annum.

The premium on a six-month call option on the euro with strike price $1.2000 is 2%.

You are trying to help decide between the following two alternatives:

Hedging with a forward contract...

Hedging using a call option on the euro...

a) Suppose that you strongly expect the euro to appreciate. In that case, which of the hedging alternatives would you recommend? Justify your recommendation. (No calculations are necessary.) (5 points)

Answer:

b) Suppose that you strongly expect the euro to depreciate. In that case, which of the hedging alternatives would you recommend? Justify your recommendation (No calculations are necessary.) (5 points)

Answer:

c) Suppose that you expect the euro to depreciate. By how much does the euro need to depreciate in order to make the call option a better alternative than the forward contract? In other words, how low does the euro have to go in value to make total cash outflow under the call option be less than that under the forward contract? Support your answer with calculations. (5 points)

Answer:

Reference no: EM131921102

Questions Cloud

What are some of the depreciation methods available : Once we determine a value for asset, we have to find a way to "allocate" or "depreciate" this cost over time. What are some of depreciation methods available

Prototype in database development : Why is it important to use a prototype in database development? Describe the usage of MS Access as a prototype tool. What are the advantages/disadvantages?

What is the scope of the change being planned : Based on the information in the study, can you thoroughly assess the environment? If so, what didyou find?If not, what additional inputs might you need to do so

Alternative paths based on variable conditions : The use of the if statement allows your program to take alternative paths based on variable conditions.

Strongly expect the euro to depreciate : Suppose that you strongly expect the euro to depreciate. In that case, which of the hedging alternatives would you recommend?

What advice could you give to the manager : Your hiring manager is frustrated at an offer that was made to a qualified applicant because the applicant has asked for more money in order to accept the job.

Determining priority : As you are reviewing the results of your various scans, what factors do you believe you would take into consideration when determining priority?

Record crown petty cash transactions during january : Crown Company established a petty cash fund of $600, Prepare the journal entries necessary to record Crown's petty cash transactions during January

Common stock as listed on balance sheet : Common Stock as listed on the Balance Sheet could include which of the following?

User Account

All Pages