Problem 4

Now is May 2005 (T = 0). Your U.S. based company has overseas operations, and it expects cash revenues of 100,000 Canadian dollars in May 2006 (T= 1) and another 100,000 Canadian dollars in May 2007 (T = 2). The spot exchange rate is $0.8 US / CAN. The risk-free interest rate is 3% in the U.S. and 4% in Canada. (Show all work)

a)One possibility to hedge your exposure to exchange rate uncertainty is to long two futures contracts on 100,000 Canadian dollars: one with one-year maturity, the other with two-year maturity. (True / False)

b)Using interest rate parity, find the equilibrium futures prices for delivery of 100,000 Canadian dollars at T=1 and at T=2.

c)Suppose you enter a two-year swap agreement. At T=1 and at T=2 you will swap 100,000 Canadian dollars for a certain fixed amount of U.S. dollars. Find this U.S. dollar amount.