BBB Inc. is a HKD-based importer who imports agricultural products from Europe. Currently BBB Inc. has an account payable of 5 million euros that will come due in 3 months. The current exchange rate between HKD and euro is CNY7.6923 per euro. The exchange rate outlook between HKD and euro is highly uncertain and BBB's treasurer has decided to hedge against the exchange rate risk by using forward contract with Nopay Bank. The 3-month forward rate today is HKD 7.9731 per euro.

 

1. Nopay Bank is concerned about the counterparty risk arising from BBB's possible default on the forward delivery date.  Suppose Nopay Bank requires BBB Inc to buy credit insurance to protect Nopay Bank against BBB's default.  DESCRIBE the financial nature of the credit insurance in terms of call or put option.   NO CALCULATION NEEDED.

 

1. Suppose the risk-free rate of interest is 5% and the volatility of the HKD/euro exchange rate is 30%.  The credit rating of BBB inc. indicates that the probability of default is 5%.  Based on the given information and your analysis in part (a) above, determine the corresponding cost of credit insurance to BBB Inc.

Answer rating: 100% (QA)

Answer The financial nature of the credit insurance for BBB Inc can be described in terms of a put option In this scenario the credit insurance serves ... View the full answer