Question 1. Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany €2,500,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in Euros rather than dollars, OTI is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information: The spot exchange rate is $.8924/€ The six month forward rate is $.8750/€ OTI’s cost of capital is 11% The Euro zone 6-month money market rates are 7%-9% pa The U.S. 6-month money market rates are 6%- 8% pa The premium (option price) for December call options with strike price $.90 is 1.5% OTI’s forecast for 6-month spot rates is $.91/€ The budget rate, or the highest acceptable purchase price for this project, is $2,300,000 or $.92/€ Assume that analysts consider the following likely exchange rate scenarios each with an equal probability of occurance (i.e. 33.3%) Strong Dollar: $0.8600 Neutral :$0.8750 Weak Dollar :$0.9500 Assume that Oregon selected to use forward hedge. What will be the expected cost of the rail cars? (Hint: Use statistical expectation to calculate the expected cost) A. $2,150,000 B. 2,160,527 C. 2,241,778 D. $2,187,500 E. $2,350,000 2. Firm “J” is a U.S.-based MNC with net cash inflows of German marks and net cash inflows of Sunland francs. These two currencies are highly negatively correlated in their movements against the dollar. Firm “K” is a U.S.-based MNC that has the same exposure as Firm “J” in these currencies, except that its Sunland francs represent cash outflows. Which firm has a higher exposure to exchange rate risk? a. Firm “J”. b. Firm “K”. c. Firms “J” and “K” have about the same level of exposure. d. Neither firm has any exposure. A. Firm “J”. B. Firm “K”. C. J and K have same level of exposure D. Neither firm has any exposure 3. Annual inflation rates in the US and Turkey were 2% and 20% and 3% and 10% in 2003 and 2004 respectively. The spot rate for the New Turkish Lira (TRY) was is 1.55 per dollar in January 2003. Calculate the expected PPP implied USD/TRY exchange rate as of end of 2004. A. USD/TRY1.8555 B. USD/TRY1.9475 C. USD/TRY1.7878 D. USD/TRY 2.1010 E. USD/TRY2.30 4. The following spot and interest rates to answer the following question: USD/EURO 1.2310-1.2340 R-USD-3-months: 3.00%-3.25% pa R-EUR-3-months: 4.00%-4.50% pa Assume that you are a banker and you bought Eur100m forward based on the forward price calculated from rates available above. However, after you entered into the contract , you did not engage in the series of transactions that you supposed to (in order to create a risk free position). In other words, you have a net exposure of EUR100m. Suddenly three months later Fed dramatically increased interest rates, which pushed the reference rates up by 2% in US. In response to interest rate hike, USD/EUR rate also moved down to: USD/EUR1.2050-1.2090. Concerned about further movements in the interest and exchange rates, you completed the loop by borrowing in Euros, converting them into USD and depositing dollars into an interest earning account (all with 9 months maturity). What would be your net loss or gain With these sharp movements in interest rates, how much money would your bank lose or gain because of the forward contract you quoted based on the given rate? A. Gain 2,700,000 B. Loss, 2,700,000 C. Gain 3,452,366 D. Loss, 3,451,366 E. None of the above 5. P&G is a US based MNC and has operations in Germany. P&G expects 120,000,000 DEM cash flows in 6 months, however due to significant volatility, cash flows are expected to fluctuate as much as 20%. In other words P&G can get DEM120m, DEM96m or DM144m depending on the economic conditions. Based on their expectations, P&G treasurers choose to sell DEM96m forward at DEM1.90and buy DEM48m put option at D…

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