1. Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy Industry. PCC owes Mitsubishi Heavy Industry 500 million yen in one year. The current spot rate is 124 yen per dollar and the one-year forward rate is 110 yen per dollar. The annual interest rate is 5% in Japan and 8% in the U.S. PCC can also buy a one-year call option on yen at the strike price of $.0081 per yen for a premium of .014 cents per yen.
(a) Compute the future dollar costs of meeting this obligation using the money market hedge and the forward hedges.
(b) Assuming that the forward exchange rate is the best predictor of the future spot rate, compute the expected future dollar cost of meeting this obligation when the option hedge is used.
(c) At what future spot rate do you think PCC may be indifferent between the option and forward hedge?
2. ADG has a €3,000,000 receivable in 214 days on September 15th. To assess alternative ways of hedging, the following data are relevant: The current spot exchange rate (S)=$1.3088/€, 7-month forward exchange rate (F)=$1.3090, the dollar interest rate (bid)=0.78% and euro interest rate (ask)=1.40%; the put option on the euro with the strike (exercise) price of $1.31 selling for a premium of 5.09 cents per euro. Here we consider and compare three alternative hedging methods as in our discussions in the textbook: Forward, money market, and option hedges.
Hedging with futures is often inconvenient due to the standardized maturities and contract size and also possibly thin trading.