Boeing just signed a contract to sell a Boeing 787 aircraft to British Airways. British Airways will be billed £26 million which is payable in one year. The current spot exchange rate is $1.40/£ and the one-year forward rate is $1.43/£. The annual interest rate is 6.0% in the U.S. and 5.0% in UK. The premium for a one-year put or call option with the exercise rate of $1.43/£ is 1%. Boeing is concerned with the volatile exchange rate between the dollar and the pound and would like to hedge exchange exposure. Four alternatives are available to Boeing to manage the exposure: 1) remain unhedged; 2) hedge in the forward market; 3) hedge in the money market; or 4) hedge in the options market. (Show all work)
(a) What action does Boeing need to take for each hedging alternative?
(b) Calculate the future dollar proceeds of the sale to British Airway under the four alternatives if the spot exchange rate becomes $1.45/£ in one year.
(c) Calculate the future dollar proceeds of the sale to British Airway under the four alternatives if the spot exchange rate becomes $1.40/£ in one year.
(d) At what future spot exchange do you think Boeing will be indifferent between the option and money market hedge?
(e) At what future spot exchange do you think Boeing will be indifferent between the option forward hedge?
(f) At what future spot exchange do you think Boeing will be indifferent between the forward and money market hedge?
(g) Illustrate the future dollar proceeds of the sale to British Airway under the four alternatives.