Question: Madison Inc imports olive oil from Chilean firms and the

Madison Inc. imports olive oil from Chilean firms, and the invoices are always denominated in pesos (Ch$). It currently has a payable in the amount of Ch$250 million that it would like to hedge. Unfortunately, there are no peso futures contracts available and Madison is having difficulty arranging a peso forward contract. Its treasurer, who recently received his MBA, suggests using the Brazilian real (R) to cross-hedge the peso exposure. He recently ran the following regression of the change in the exchange rate for the peso against the change in the real exchange rate:
ΔCh$/US$ = 1.6(ΔR/US$)
a. There is an active market in the forward real. To crosshedge Madison’s peso exposure, should the treasurer buy or sell the real forward?
b. What is the risk-minimizing amount of reals that the treasurer would have to buy or sell forward to hedge Madison’s peso exposure?

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  • CreatedJune 27, 2014
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