Mini-Case Carrier Lumber Evaluates Its Futures Suppose that Carrier Lumber Ltd, a Canadian forest prod- By...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Mini-Case Carrier Lumber Evaluates Its Futures Suppose that Carrier Lumber Ltd, a Canadian forest prod- By using options rather than futures, management would ucts company, sells lumber to Home Depot. In return, Home Depot will pay Carrier US$1,000,000 in 90 days. At a current exchange rate of US$0.83/Can$, the receiv- able is worth Can$1,204,819. However, if the Cana- dian dollar appreciates by US$0.01 within the next three months, the receivable will lose Can$14,343 in value. Car- rier is concerned about the potential for losses as it has been advised that the spot rate in 90 days can vary between US$0.81 and US$0.85. In order to offset any potential losses in the value of the U.S. dollar receivable, Carrier is considering the use of Canadian dollar futures to hedge its expo- sure. Since each Canadian dollar futures contract is worth Can$100,000, Carrier would buy 12 futures con- tracts if it decided to hedge with futures. This fig- ure is found by dividing the face value of the expo- sure (US$1 million = Can$1,204,819) by the contract value (Can$100,000) and rounding to the nearest con- tract. If the Canadian dollar appreciates within the next three months, the futures position will gain US$12,000 for every one cent increase in the USD/CAD exchange rate (US$1,000 x 12 contracts). This figure translates into a gain of Can$14,458 at today's exchange rate (12,000/0.83). The current three-month futures rate is $0.8325. Carrier, at the suggestion of its banker, is also consid- ering the use of currency options to hedge its receivable. be able to minimize its downside risk in the event that the Canadian dollar appreciates, yet at the same time benefit from any depreciation that may occur within the next three months. To hedge its downside risk, Carrier would buy 24 three-month Canadian dollar call options (since each Can$ options contract is worth Can$50,000). If it used currency options to hedge its receivable, Carrier decided that it would buy these call options with an at-the-money strike price. The premium paid for these options would be around US$0.87 per Can$100, or Can$12,578.31 at the current exchange rate (0.87 x 1,000 12/0.83). Questions 1. Develop a table showing Carrier's Can$ profit and loss associated with the futures position and the options position within its range of expected exchange rates at US$0.01 increments. Ignore transaction costs and margins. 2. Show the total Can$ cash flow to Carrier (hedge plus the gain or loss on the hedge) using the options and futures contracts, as well as the unhedged position within the range of expected future exchange rates. 3. What is Carrier's break-even 90-day spot price on the option contracts? On the futures contracts? 4. Would you recommend Carrier hedge with the futures contracts or the options contracts? Why? Mini-Case Carrier Lumber Evaluates Its Futures Suppose that Carrier Lumber Ltd, a Canadian forest prod- By using options rather than futures, management would ucts company, sells lumber to Home Depot. In return, Home Depot will pay Carrier US$1,000,000 in 90 days. At a current exchange rate of US$0.83/Can$, the receiv- able is worth Can$1,204,819. However, if the Cana- dian dollar appreciates by US$0.01 within the next three months, the receivable will lose Can$14,343 in value. Car- rier is concerned about the potential for losses as it has been advised that the spot rate in 90 days can vary between US$0.81 and US$0.85. In order to offset any potential losses in the value of the U.S. dollar receivable, Carrier is considering the use of Canadian dollar futures to hedge its expo- sure. Since each Canadian dollar futures contract is worth Can$100,000, Carrier would buy 12 futures con- tracts if it decided to hedge with futures. This fig- ure is found by dividing the face value of the expo- sure (US$1 million = Can$1,204,819) by the contract value (Can$100,000) and rounding to the nearest con- tract. If the Canadian dollar appreciates within the next three months, the futures position will gain US$12,000 for every one cent increase in the USD/CAD exchange rate (US$1,000 x 12 contracts). This figure translates into a gain of Can$14,458 at today's exchange rate (12,000/0.83). The current three-month futures rate is $0.8325. Carrier, at the suggestion of its banker, is also consid- ering the use of currency options to hedge its receivable. be able to minimize its downside risk in the event that the Canadian dollar appreciates, yet at the same time benefit from any depreciation that may occur within the next three months. To hedge its downside risk, Carrier would buy 24 three-month Canadian dollar call options (since each Can$ options contract is worth Can$50,000). If it used currency options to hedge its receivable, Carrier decided that it would buy these call options with an at-the-money strike price. The premium paid for these options would be around US$0.87 per Can$100, or Can$12,578.31 at the current exchange rate (0.87 x 1,000 12/0.83). Questions 1. Develop a table showing Carrier's Can$ profit and loss associated with the futures position and the options position within its range of expected exchange rates at US$0.01 increments. Ignore transaction costs and margins. 2. Show the total Can$ cash flow to Carrier (hedge plus the gain or loss on the hedge) using the options and futures contracts, as well as the unhedged position within the range of expected future exchange rates. 3. What is Carrier's break-even 90-day spot price on the option contracts? On the futures contracts? 4. Would you recommend Carrier hedge with the futures contracts or the options contracts? Why?
Expert Answer:
Answer rating: 100% (QA)
Based on the information in the case 1Develop a table showing Carriers Can profit and loss associated with the futures position and the options position within its range of expected exchange rates at ... View the full answer
Posted Date:
Students also viewed these finance questions
-
Mr . Fassler owned a 2 0 - acre ranch with a house on it in Stanislaus County. He agreed to sell it to Mr . Williams for $ 1 1 4 , 0 0 0 . For income tax reasons, Fassler didnt want to collect the...
-
Suppose that Carrier Lumber Ltd, a Canadian forest products company, sells lumber to Home Depot. In return, Home Depot will pay Carrier US$1,000,000 in 90 days. At a current exchange rate of...
-
1. Assume that U.S. and Argentine investors require a real return of 2 percent. If the U.S. nominal interest rate is 5 percent, and Argentina's nominal interest rate is 7 percent, then according to...
-
Of the following data storage technologies: Permanent Data Storage COBOL Hierarchical DBMS Network DBMS Relational DBMS Object-oriented DBMS XML a. Which requires the most understanding about how the...
-
If other factors are held constant, explain how each of the following influences the value of the independentmeasures t statistic and the likelihood of rejecting the null hypothesis: a. An increase...
-
Last year Acme paid Ralph $15,000 to install a new air-conditioning unit at its headquarters building. The air conditioner did not function properly, and this year Acme requested that Ralph return...
-
Components of Cash} The office manager for Rajachitra Products had accumulated the following information at the end of a recent year: \section*{Exercise Item Accounts receivable Change for cash...
-
The following events occurred over the course of a year at Bagby Corp., which uses a job order costing system: 1. Direct materials purchases totaled $460,000. 2. $230,000 of indirect materials were...
-
/ 1 Use the polar form of the complex number 3 (\\/ -| i) to nd a value in Cartesian form, z = x + iy. Give the cube root With the smallest argument. NOTE: Enter the exact answer or round real and...
-
Using a table similar to that shown in Figure 3.6, calculate the product of the octal unsigned 6-bit integers 62 and 12 using the hardware described in Figure 3.3. You should show the contents of...
-
A strain gouge with a resistance 350 ohm, and a gauge faster 2 is used to monitor a signal with amplitude 1800 win/in. If the frequency is 200 Hz, and a constant veltage potentiometer is used with a...
-
List five questions the preliminary survey can answer for internal auditors.
-
A deficient condition was described as follows in the draft on an audit report: In our test of automotive vehicles, we found that 35 automobiles had been serviced at intervals of 9 to 12 months. We...
-
Distinguish between the authorization for and the objectives of an activity.
-
How may the significance and the nature of deficiency findings be described?
-
Describe a walk-through and point out its benefits.
-
Help on this . Learning Objective 4 E-F:8-17 Accounting for petty cash Jackie's Dance Studio created a $220 imprest petty cash fund. During the month, the 2. Cash Short & Over $15 fund custodian ...
-
Draw a Feynman diagram for the reaction n + v p + .
-
Why are market value proportions preferred to book value proportions in the calculation of the weighted average cost of capital?
-
If both the Dividend Valuation Model and the Capital Asset Pricing Model produce estimates of the cost of common stock, how is it possible to end up with two different numerical estimates?
-
List at least three problems that are encountered in calculating the cost of capital for an actual firm.
Study smarter with the SolutionInn App