Spot Exchange

Homework # 4

Slide 47 Exercise (Chapter 8)
An American exporter has just sold €100,000 worth of shoes to a French customer. Payment is due in one year. Interest rates in dollars are 7.10 percent in the U.S. and 5 percent in the euro zone. The spot exchange rate is $1.25/€1.00. Use a money market hedge to eliminate the exporter’s exchange rate risk.

Spot Exchange Rate= $1.25/€1.00
i$=7.10%
i€= 5%
Borrow €100,000/ (1+0.05) at t = €95,238.095
Exchange €100,000/ (1+0.05) for $ at the prevailing spot rate, or $119,047.619
119,047.62$ x 1+7.1%= 127,500$
By this hedge the exporter would receive 127,500$ instead of 125,000$ (at spot rate). Or €102,000 instead of €100,000€. The exporter is earning €2,000 (at spot rate).
At maturity (one year after), the exporter will owe an amountof € which can be paid with his receivable, therefore eliminating or reducing the exposure to the dollar-euro exchange rate.


















4. Boeing
Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €20
million which is payable in one year. The current spot exchange rate is $1.05/€ and the one-year forward
rate is$1.10/€. The annual interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with
the volatile exchange rate between the dollar and the euro and would like to hedge exchange exposure.

(a) It is considering two hedging alternatives: sell the euro proceeds from the sale forward or borrow
euros from the Credit Lyonnaise against the euro receivable. Which alternative would you recommend?Why?
• Forward hedge, the future dollar proceeds will be (20,000,000)(1.10) =$22,000,000.

• Money market hedge,the firm has to first borrow the PV of its euro
receivable, i.e., 20,000,000/1.05 =€19,047,619. The firm can exchange this euro amount into
dollars at the current spot rate to receive: (€19,047,619)($1.05/€) = $20,000,000, and should invest
the dollar interest rate for oneyear to yield: $20,000,000(1.06) = $21,200,000.

• The company will receive $800,000 more by using forward hedging

(b) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two
hedging methods?
IRP, F = S(1+i$)/(1+iF). The “indifferent” forward rate will be:
F = 1.05(1.06)/1.05 = $1.06/€.


Minicase: Airbus’ Dollar Exposure

Airbus sold anaircraft, A400, to Delta Airlines, a U.S. company, and billed $30 million payable in six
months. Airbus is concerned with the euro proceeds from international sales and would like to control
exchange risk. The current spot exchange rate is $1.05/€ and six-month forward exchange rate is $1.10/€
at the moment. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for apremium of €0.02 per U.S. dollar. Currently, six-month interest rate is 2.5% in the euro zone and 3.0% in
the U.S.

a. Compute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using a
forward contract.

• Airbus will sell $30 million forward for €27,272,727 = ($30,000,000) / ($1.10/€).


b. If Airbus decides to hedge using money market instruments, what actiondoes Airbus need to take?
What would be the guaranteed euro proceeds from the American sale in this case?

• Airbus will borrow the present value of the dollar receivable, i.e., $29,126,214 = $30,000,000/1.03, and
If they sell the dollar proceeds spot for euros: €27,739,251. This is the euro amount that Airbus is going to keep.



c. If Airbus decides to hedge using put options on U.S.dollars, what would be the ‘expected’ euro
proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as
an unbiased predictor of the future spot exchange rate.

• The expected future spot rate is less than the strike price of the put option, i.e., €0.9091< €0.95,
Airbus expects to exercise the option and receive €28,500,000 = ($30,000,000)(€0.95/$). This...