Fin 3551 Problem Set 3

Bradley McNamara

Problem Set 3

Corporate risk management 2

1.*(repeat-corp risk1) Dow Chemical has sold SFr 25 million in chemicals to Ciba-Geigy. Payment is due in 180 days.

Spot rate: $0.7957/SFr

180-day forward rate: $0.8095/SFr

180-day U.S. dollar interest rate (annualized): 5.25%

180-day Swiss franc interest rate (annualized): 1.90%

180-day call option at $0.80/SFr: 2% premium

180-day put option at $0.80/SFr: 1% premium

a. What is the hedged value of Dow’s receivable using the forward market hedge?

Dow Chemical can use a forward contract to lock in a value of $20,237,500 (25,000,000 x 0.8095) for its receivables.

b. Explain how Dow can use the money market hedge?

Dow would borrow the present value of the SFr 25 million receivable, which equals SFr 24,764,735 (25,000,000/1.0095) at the 0.95% 180-day interest rate (1.9%/2). This franc amount equals a dollar amount of $19,705,300 at the current spot rate of $0.7957/SFr. By investing semiannually at 2.625% (5.25%/2), Dow will have $20,222,564 after 180 days (1.02625 x $19,705,300). It can then pay off the Swiss franc loan with the SFr 25 million in collected receivables.

c. How should Dow use currency options to hedge its receivable?

Dow should use the forward contract option because it has a higher payoff. Dow would be speculating on the future spot price of the Swiss franc if it bought the put option.

2. Magnetronics, Inc., a U.S. company, owes its Taiwanese supplier NT$205 million in three months. The company wishes to hedge its NT$ payable. The current spot rate is NT$1 =...