Problem:
Avalon is the US-based company which exports goods to Switzerland. Avalon anticipates receiving payment on a shipment of goods in 3 months. Since payment will be in Swiss francs, the US Company wants to hedge against a decline in value of Swiss franc over the next 3 months. The US risk free rate is 2% and Swiss risk-free rate is 5%. Suppose that interest rates are expected to remain fixed over the upcoming six (6) months. The current sport rate is $0.5974.
Required:
i. Indicate whether Avalon must employ a long or short forward contract to evade the currency risk.
ii. Compute the no-arbitrage price at which Avalon could enter in a forward contract which expires in 3 months.
iii. It is now 30 days since Avalon entered in the forward contract. The spot rate is $0.55. Interest rates are the same as before. Compute the value of Avalon forward position.
iv. Advise to Avalon under what scenario is it better to employ an option contract as compared to a forward contract and in the above case, would the employ of an option contract more be advantageous.