Suppose that Mullen Co, a U.S.-based MNC, knows that it will need 200,000 pounds in one year in order to purchase supplies. It is considering acurrency call option to hedge this payable. Currency call options on the pound with expiration dates in one year currently have an exercise price of$1.21 and a premium of $0.02.On the following graph, use the blue points (circle symbols) to plot the contingency graph for hedging this payable with a call option. Plot the pointsfrom left to right in the order you would like them to appear. Line segments will connect automatically. Plot the 3 blue points for the following poundspot rates: $1.18, $1.21, $1.27.Note: The vertical axis measures dollar cash outflows from the hedge, which includes the price paid for pounds and any option premium.Dollar Cash Outflows from Hedge (Dollars per Pound)1.271.261.251.241.231.221.211.201.191.181.171.161.181.19 1.20 1.211.22 1.23 1.24 1.25 1.26Pound Spot Rate in One Year (Dollars per Pound)Contingency Graph?

To plot the contingency graph for hedging the payable with a call option, we need to calculate the…

Answered: Suppose that Mullen Co, a U.S.-based…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Suppose that Mullen Co, a U.S.-based MNC, knows that it will need 200,000 pounds in one year in order to purchase supplies. It is considering a currency call option to hedge this payable. Currency call options on the pound with expiration dates in one year currently have an exercise price of $1.20 and a premium of $0.04. On the following graph, use the blue points (circle symbols) to plot the contingency graph for hedging this payable with a call option. Plot the points from left to right in the order you would like them to appear. Line segments will connect automatically. Plot the 3 blue points for the following pound spot rates: $1.16, $1.20, $1.26. Note: The vertical axis measures dollar cash outflows from the hedge, which includes the price paid for pounds and any option premium. Dollar Cash Outflows from Hedge (Dollars per Pound) 1.26 1.25 1.24 1.23 1.22 1.21 1.20 1.19 1.18 1.17 1.16 1.15 1.14 + 1.16 1.17 1.18 1.19 1.20 1.21 1.22 1.23 1.24 1.25 Pound Spot Rate in One Year (Dollars…
Suppose that Mullen Co, a U.S.-based MNC, knows that it will need 200,000 pounds in one year in order to purchase supplies. It is considering a currency call option to hedge this payable. Currency call options on the pound with expiration dates in one year currently have an exercise price of $1.21 and a premium of $0.02. Mullen Co. wishes to use its own forecast of what the spot rate might be for the pound one year from now. • $1.18, with 30.00% probability • • $1.22, with 60.00% probability • $1.24, with 10.00% probability For each scenario in the following table, fill in the dollar amount paid per unit for the call options (5th column), the total dollar amount paid for 200,000 pounds when using the call options (6th column), and whether Mullen would exercise the options (7th column) Pound Spot Rate in 1 Scenario Year Option Premium Per Unit Cost of Owning Option Total Cost of Owning Options, With Premium Dollar Amount Paid for 200,000 Pounds when Owning Call Options Exercise Options?…
This question will compare two different arbitrage situations. Recall that arbitrage should equalize rates of return. We want to explore what this implies about equalizing prices. In the first situation, two assets, A and B, will each make a single guaranteed payment of $100 in 1 year. But asset A has a current price of $80 while asset B has a current price of $90.a. Which asset has the higher expected rate of return at current prices? Given their rates of return, which asset should investors be buying and which asset should they be selling?b. Assume that arbitrage continues until A and B have the same expected rate of return. When arbitrage ceases, will A and B have the same price?Next, consider another pair of assets, C and D. Asset C will make a single payment of $150 in one year while D will make a single payment of $200 in one year. Assume that the current price of C is $120 and that the current price of D is $180.c. Which asset has the higher expected rate of return at current…
Kansas Corp., an American company, has a payment of €5.3 million due to Tuscany Corp. one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $5,888,889, but Kansas faces the risk that the €/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €5.3 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $103,000 for a one-year call option on €5.3 million at an exchange rate of 0.88 €/$. a. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each strategy? (Round your answer to the nearest whole dollar amount.) Strategy 1 Strategy 2 Net Dollar Cost b. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each strategy? (Round your answer to the nearest whole…
An Omani importer will receive commodities from USA and he has to pay an amount of USD 250,000 next month. Which of the below markets is well suited to offer hedging protection against this transactions risk exposure? a. Inflation rate market O b. Transactions market C. Spot market O d. Forward market
tractor has a cost of $ 1m for a given specification. If the current $: £ rate is 1.3500:1,i) What would be the prices in one year in each country given that the inflation rate in the U.S is 8% and in the UK is 5%.ii) What is the effective exchange rate in one year’s time?
Suppose a European call option to buy 1 euro for 1.40 CAD costs 0.08 CAD. The option maturity is in two months and the forward exchange rate for the same maturity is 1.50 CAD per euro. What arbitrage opportunity exists? Explain how you can exploit this opportunity and how much the profit is. (Ignore the time value of money)
Consider the following situation. It costs $1.2900 to purchase £1 for immediate delivery. UK interest rates are 0.75% p.a. US interest rates are 1.5% p.a. What must be the 1 year forward rate at which you can purchase £ with $? Assume that there is no default risk, no transaction costs, no bid-ask spreads, etc. Provide your answer to 4 decimatplaces, for example, if you think the answer is 1.2900 $/£, enter '1.2900' Answer:
Masons intends to purchase goods valued at £2.09 million, with payment due in one year. To mitigate the exchange rate risk associated with the £2.09 million payment, Masons is considering the forward market hedging strategy. Using the data provided in Table 1, determine the cost in Chinese yuan (CNY) when employing the forward market hedging strategy. (Please input the value as a whole number, excluding any signs or symbols). TABLE 1 For Chinese yuan (CNY) Spot rate £0.3755/CNY One-year forward rate £0.5381/CNY One-year CNY deposit and borrowing rate 8.48% One-year call options Exercise price = £0.52 Premium = £0.03 One-year put options Exercise price = £0.58 Premium = £0.06 For British Pound (£) Spot rate CNY3.5909/£ One-year forward rate CNY1.918/£ One-year £ deposit and borrowing rate 4.71% One-year call options Exercise price = CNY1.64 Premium = CNY0.17…
Hedging using forward rates: Assume the hypothetical spot rate between the JPY and USD was 101.25 JPY per USD. Suppose you are purchasing 2000000 JPY worth of microprocessors deliverable (product and payment) in 3 months with the contract set up between you and your supplier on Friday. How much is that shipment worth in USD. Assume that you want to hedge against exchange rate risk, and go to the bank. The financial specialist at the bank gives you the official 3 month forward rate at 101.18 JPY per USD. What does that imply for your payment to the bank in 3 months?
The British pound (GBP) is currently priced at $1.50 and the Swiss Franc (SF) is priced at $0.50, while the quoted cross rate is 1GB =3.50 SF. If you have $1,000, can you make an arbitrage profit? If so, describe the steps required to create the opportunity and show the profit. If there is no arbitrage profit opportunity, describe how you arrived at that decision.
Kansas Corporation, an American company, has a payment of €5.9 million due to Tuscany Corporation one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $ 6,555,556, but Kansas faces the risk that the €/S rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €5.9 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $109,000 for a one-year call option on €5.9 million at an exchange rate of 0.88 €/$. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount.

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