Question: You submitted a bid to do some construction work in Saudi Arabia and, to your surprise, you won the bid. You will receive an initial
You submitted a bid to do some construction work in Saudi Arabia and, to your surprise, you won the bid. You will receive an initial payment of 1.1 million Saudi Riyals (the local currency) today and another payment of 1.1 million Riyals when you finalize construction. You do not need to hedge the initial 1.1 million Riyals since you know that the current exchange rate is $0.27 USD. You are expecting that you will finish the work in 1 year and so you will receive the remaining 1.1 million Riyals in 1 year.
Since you are taking FIN403 and learned about hedging, you want to explore how much would hedging the 1.1 million riyals would cost and what would your expected profit be under each hedging option. You want to find out your expected profit if you choose to do a forward hedge, money market hedge, and option hedge. The expected profit of each hedge will help you decide which, if any, hedge you will carry out.
Use the following inputs to estimate the expected payout if you choose not to hedge.
| Price | ||
| Spot Rate | $0.27 | |
| 1 yr forward | $0.24 | |
| Future Spot Estimates | Probability | |
| $0.22 | 20.00% | |
| $0.23 | 20.00% | |
| $0.24 | 35.00% | |
| $0.26 | 25.00% | |
| Put Option | ||
| Exercise | $0.25 | |
| Premium | $0.02 | |
| Call Option | ||
| Exercise | $0.23 | |
| Premium | $0.05 | |
| Interest Rates | US | Saudi Arabia |
| Deposit | 0.10% | 1.00% |
| Borrowing | 0.50% | 3.00% |
Select one:
a.
$297,000
b.
$264,000
c.
$248,800
d.
$262,900
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