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FERGS Pic has export orders from a company in Singapore for 300,000 widgets and from a company in Indonesia for 150,000 widgets. The unit cost to FERGS of producing widgets is 60.60. The unit sales price to Singapore is 2.995 Singapore dollars (SG $) and to Indonesia, 2,450 Rupiahs (RP). Both orders are subject to credit terms of 60 days and are payable in the currency of the importers. It is considered possible that payments from either could be delayed for as long as 90 days. The Indonesian customer has offered to FERGS the alterative of being paid US$ 125,000 in three months time instead of payment in Rupiahs. The Rupiah is forecast to depreciate in value during the next year by 30% (from an Indonesian perspective) against the USD. FOREIGN EXCHANGE RATES (MID RATES) 1 US $ = SG $ 16= SG $ 16= US $ 1 6 = RP Spot....=.= =14:1459 ...2.1378 3.1800 1.4850 2481 1 month forward.... ...2.1132 3.1620 1.4963 No 2 months forward .. .2.0964 3.1545 1.5047 market 3 months forward . .2.0915 3.1570 1.5100 Assume that, in the domestic economy, any foreign currency holding must be immediately converted into euro MONEY MARKET RATES (% PER YEAR) Doposit Borrow Irish clearing bank.. 6.5% 10% Singapore bank...... .....4% 8% Indonesian bank .15% Not available/relevant US domestic bank.... 1 1% These interest rates are fixed for immediate deposits or borrowing over a period of two or three months. Given the information provided, calculate on a simple interest basis the Euro receipts that FERGS can expect from its sales to Singapore and Indonesia, if the foreign exchange risk is hedged using: a) The money markets. (50 marks) b) Forward exchange contracts. (50 marks) 2 Queen's Economics Group has just published projected inflation rates for the United States for the next five years. U.S. inflation is expected to be 7 percent per year, and U.K. inflation is expected to be 4 percent per year. (a) If the current exchange rate is $1.20/E, what should the exchange rates for the next five years be? (b) Suppose the U.S. inflation over the next five years turns out to average 3.5%, U.K. inflation average 1.5%, whereas the exchange rate in five years is $1.10/E. What happen to the value of the pound over this five-year period? 100 marks4. You are a U.S.-based company that just imported some raw materials for 6200,000 from France. You owe (200,000 to the French supplier in one year. You are concerned about the amount in dollars you will have to pay for this purchase in one year. Suppose: Current Spot exchange rate is $1.50/6 One-year Forward exchange rate is $1.25/E U.S. interest rate is 3.00% per year Interest rate in Europe is 4.00% per year Call option with strike price of $1.30/C is available with premium of $0.1/6 Put option with strike price of $1.30/6 is available with premium of $0.2/E You forecast that the spot exchange rate in one year could be $1.20/6, $1.30/6, $1.40/6, or $1.50/6 with equal probability. a. Suppose you decide to do nothing. In one year, what will be the dollar cost in the four possible scenarios? (2 points) b. Explain in detail how you can lock in the exact dollar cost of this purchase by using forward contract. Specifically, do you take a long or short position in a 6 forward contract and for how much amount? What dollar cost can you lock in with this strategy? (4 points) c. Explain in detail how you can lock hedge your position using money market hedge. Write down the detailed steps one needs to take to implement the money market hedge and calculate the dollar cost in each of the four scenarios. (6 points) d. Explain in detail how you can hedge using option. Should you take a long or short position in put or call options on euros? Write down whether you will exercise the option (i.e., is it in the money, at the money, or out of the money?) and calculate the dollar cost (including option premium you paid) in each of the four possible scenarios. (6 points) Hint: at the end, provide a table that summarizes the dollar cost in each scenario like the following: State Future spot rate Cost in Euro Unhedged Forward Money Market Option 1 1.2 200,000.00 2 1.3 200,000.00 3 1.4 200,000.00 A 1.5 200,000.003. (2) Consider the supply and demand model below Demand: q=-p+3+4x+q Supply: p=q+1+6 a) Find the reduced form equations for p and q. b) Suppose that x - 2. Find the equilibrium p and q (i.e., the values if e, = e, = 0 ). c) Suppose that x - 5. Find the equilibrium p and q (i.e., the values if e, = e, = 0 ). d) If we have / observations on p, q, and x, can we consistently estimate the reduced form equations by OLS? Why? e) To illustrate part (d), note that the slope of the reduced for curve for p is equal to Ap/Ar . Using the values from (b) and (c) compute Ap/Ar . Is the value equal to the reduced form coefficient for p? f) Do the same thing for Ag/Ar . Is the value equal to the reduced form coefficient for q? g) If we have A observations on p, q, and x, can we consistently estimate the supply equation by OLS? Why? h) To illustrate part (g), note that the slope of the supply curve is Aq/Ap. Using the values from (b) and (c) compute Ag/Ap. Is the value equal to the slope coefficient for the supply equation? i) . If we have / observations on p, q, and x, can we consistently estimate the demand equation by OLS? Why or why not?1. A collar is established by hoping a share of stock for $5, buying a 'month put option with exercise price $45, and writing a 6-month call option with exercise price $55. Based on the volatility of the stock. you calculate that for a strike price of$45 and ammo-it,r of IS months, Midi} = .6, whereas for the exercise price of $55, N(d1) = .35. E. h. Plot the payoff of this collar as a tnction of the stock price at the option expiration date. What will be the gain or loss of the collar if the stock price increases by 51? What happens to the delta of the pottfolio if the stock price becomes very:r large? if the costs ofthe put and the cell position used in the construction of the collar were $3 and $5, respectively, what will he the total rehnn to this position if at maturity,Ir the stock price is $55