Question 1 (8 points)

Wellman Inc., a Hong Kong-based company, just bought an Italian fashion brand for 90M, which the company will pay for in one years time.

(a) (3 points) If Wellman uses a forward contract to hedge the full amount of this purchase at the one-year forward exchange rate of HK$10.5/, should Wellman buy or sell the euros forward? After carrying out this forward hedge, how much does Wellman need to pay (in HK$) in one years time?

Answer:

(b) (3 points) If Wellman sets up a money market hedge to fully hedge its euro payable, where the current spot exchange rate S_HK$/ = HK$11/, the one-year HK$ interest rate i_HK$ = 5%, and the one-year euro interest rate i = 4%, how much does Wellman need to pay (in HK$) in one years time?

Answer:

(c) (2 points) What is the level of the one-year forward exchange rate in HK$/ that will make Wellman indifferent between a forward market hedge and the money market hedge described in part (b)?

Answer: