Wellington Inc., U.K.-based manufacturer of industrial equipment, just acquired 100% shares of a publicly listed company in South Korea that produces semiconductors. The agreed price of this acquisition was Won 700 million. Won 200 million has already been paid, and the remaining Won is due in six months. The current spot rate is Won1,616/£, and the 6-month forward rate is Won1,575/£. The six-month Korean won interest rate is 15% per annum, the six month UK dollar rate is 3.5 % per annum. Wellington can invest at these interest rates, or borrow at 2% per annum above those rates. A six-month call option on won with a 1,550/£ strike rate has a 3.6% premium, while the six-month put option at the same strike rate has a 2% premium. Wellington's weighted average cost of capital (WACC) is 11.25%. Used the above information, please answer the following questions.

a) If Wellington choose to remain uncovered without implementing any hedging strategies, what are the possible outcomes? (Please answer this question with numerical examples)

b) If Wellington choose to hedge the transaction exposure by foreign exchange forward, what is the outcome?

c) If Wellington choose the money market hedging, what is the payoff?

d) If Wellington can use foreign currency options to hedge the foreign exchange risk, what are the possible outcomes?

e) Determine the break-even rate between forward and money market hedging and explain your result.

f) Show the trading range for the pound that defines the breakeven points for the option hedging compared with the other strategies and explain the results. (Please show the upper bound and lower bound of the exchange rate)

g) Based on all the strategies above, what is your recommendation? Please explain your reason.

Answer rating: 100% (QA)

a If Wellington chooses to remain uncovered without implementing any hedging strategies there are three possible outcomes The first outcome is that the value of the won appreciates and Wellington pays ... View the full answer