Problem 1: On July 1, an American auto dealer enters into a contract to purchase 20 British sports cars with payment to be made on November 1. Each car will cost 35,000 pounds. The dealer decides to conduct a long hedge with currency futures based on the following quotes on July 1:
Current exchange rate: $1.6190/£
December pound futures contract price: $1.5780/£
One pound futures contract:£62,500
Suppose that, on November 1, the spot rate is $1.7420/£ and the December pound futures contract price is $1.7375/£.
Questions:
1. If the dealer closes his position on November 1, will he make a profit or loss? How much is it?
2. How much does the dealer effectively pay for the 20 cars?
Problem 2: Fresno Corporation will need £343,800 in 180 days to pay for shipments of British components to its US-based assembly plant. The firm decides to take a hedge with a call option. Financial market data are as follows:
Spot rate of pounding sterling:$1.50/£
Premium on a 180-day call option at $1.6720/£:$0.02/£
Standard value per contract:£31,250
Questions:
1. How many contracts does Fresno have to purchase?
2. What is the total premium it has to pay?
3. If the spot rate at maturity is $1.6560/£, should Fresno exercise the option? Why or why not?
4. Suppose the spot rate at maturity is $1.6900/£ and Fresno exercises its option. What is the total amount that the firm pays for the £343,800? How much would it pay if it did not buy a call option?