1. Larkin Hydraulics , a wholly owned subsidiary of Caterpillar (U.S.), sold a 12 megawatt compression turbine...
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1. Larkin Hydraulics, a wholly owned subsidiary of Caterpillar (U.S.), sold a 12 megawatt compression turbine to Rebecke-Terwilleger Company of the Netherlands for 4,000,000, payable in three months (90 days). Larkin derived its price quote of 4,000,000 by dividing its normal U.S. dollar sales price of $4.320,000 by the then current spot rate of $1.0800/. Four approaches are possible: | |||||||
1. Hedge in the forward market. The 3-month forward exchange quote was $1.1060/. | |||||||
2. Hedge in the money market. Larkin could borrow euros in the Libor market at 8% per annum and invest in at 5% p.a. In the USD Libor market the firm can borrow at 7% p.a. and invest at 4% p.a. | |||||||
3. Hedge with foreign currency options. 90 day put options are available at strike price of $1.1000/ for a premium of 2.0% per contract. 90 day call options with a strike at $1.1000/ could be purchased for a premium of 3.0%. | |||||||
4. Do nothing. Larkin could wait until the sales proceeds were received in August and sell the euros received for dollars in the spot market. | |||||||
Larkin's banker forecasts that the exchange rate in 90 days will be $1.1400/. What should Larkin do? | |||||||
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