1.Eric is purchasing a put option to hedge his transaction exposure. It has an underlying asset of MXN 295,220, a strike price of USD 0.053 per MXN. What is his payoff on this option if at maturity the spot rate is USD 0.044 per MXN, and the present value of the option premium is USD 2,709?

2.Assuming Eric has set up his hedge correctly, and has completely hedged his transaction exposure, what foreign currency is Eric exposed to? What is the size of his exposure? Does he owe foreign currency, or is he owed foreign currency? You may assume that Eric does his books in USD.

3.In this case, would Eric have been better or worse off if he had instead used a forward contract with the same maturity and underlying asset, and a contractual exchange rate of USD 0.056 per MXN?

4.Transaction exposures can be hedged with either forwards or options. List one benefit and one drawback of using each of these securities to hedge transaction exposure.

5.ABC is a Canadian company that manufactures snowblowers, and XYZ is an American company that manufactures small gasoline engines. As these two firms does a great deal of business with each other, and would be adversely affected if a major supplier or customer went out of business due to unexpected exchange rate fluctuations, they have decided to enter into a risk sharing agreement. ABC pays XYZ for engines in Canadian dollars, converting the USD price into CAD. If the spot rate on the invoice date is between CAD 0.70 per USD and CAD 0.85 per USD, the spot rate is used to do the conversion. If the spot rate is outside of that range, the rate is moved half the distance back towards the band of acceptable rates. Today, ABC is buying USD $110,682 worth of snowblower engines, and the exchange rate is currently CAD 0.91 per USD. What is ABC's gain or loss from this risk sharing agreement? Please give your answer to the nearest CAD.

6.How would ABC and XYZ likely respond if this spot rate is now the equilibrium rate, and exchange rates will likely stay close to this value for the foreseeable future?

7.You own a Mexican firm that manufactures truck transmissions. One year from today, you have agreed to purchase CAD 1,113,080 worth of steel from a Canadian supplier, and would like to protect yourself against exchange rate risk using a forward market hedge. The current spot rate is CAD 0.058 per MXN. You can borrow or lend CAD at 2.4%, and MXN at 2.5%. How many MXN would you need to borrow or lend to set up this hedge? Represent borrowing as positive numbers and lending as negative numbers. Please give your answer to the nearest MXN.

8.Are there any risks you have exposed yourself to by entering into this forward market hedge?

9.A bushelof rye currently costs USD 4.96, and the exchange rate is currently USD 0.75 per CAD. What would you expect the price of a bushel of rye to cost in CAD if the Law of One Price holds? Please give your answer to the nearest Canadian cent.

10.You own a Canadian distillery that makes rye into whiskey. If the current price of rye in CAD is CAD 5.00 per bushel, what direction would you expect the price of Canadian rye to move in, assuming there are relatively few restrictions on trading agricultural products between the US and Canada. Is there any way you could alter your operations to benefit from or reduce the downside of this situation?

Answer rating: 100% (QA)

1 To calculate Erics payoff on the put option we need to determine whether the option will be exercised or not based on the spot rate at maturity Spot rate at maturity USD 0044 per MXN Strike price US... View the full answer