(Hedging exchange rate risk) You are a sales representativeof an Estonian trading companythat exports dried cranberries to United Kingdom. Under the terms of the contract, in one year you will deliver 100 tons of cranberries for 5 pounds a kilogram. Your cost of obtaining cranberries from local suppliers is 7 EUR per kilogram. You may assume that all cash flows occur in exactly one year.
QUESTIONS: (SHOW ALL STAGES OF CALCULATIONS)
A) Plot (in a graph) your profits in euros from the contract as a function of the excahnge rate in one year, for exchange rates from 0,50 EUR/GBP (with increments of 0,10). Label this line "unhedged profits". Explain carefully the exposure to exchange rate risk.
B) Suppose that the current one-year forwardexchange rate is 0,60 EUR/GBP and you consider setting up a forward hedge. Please explain how exactly would you set up the hedge and plot your combined profits from the contract and the forward contract as a function of the exchange rate in one year. Label this line as "forward hedge".
C) Compare and explain result from b with results to a.