Problem 1

Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed 30 million which is payable in one year. The current spot exchange rate is $1.05/ and the annual inter- bank interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and wants to hedge its exposure through a forward hedge.

a) What kind of forward contract should they enter, and what is the fair price of that forward contract?

b) Suppose the actual one-year forward rate is $1.06/. Describe the forward hedge including all related cash-flows.

c) A month passes, the spot rate is now $1.08/. What is the value of the forward position Boeing entered in b)?

One of Boeings consultants suggests thinking about a money market hedge instead. Boeing can borrow at 50bps above the inter-bank interest rate in the U.S. and also in France, while the interest on deposits that they get is 50bps below the inter-bank rates.

d) Describe the money market hedge including all related cash-flows. Should Boeing prefer the money market hedge to the forward hedge?

e) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods?