finance technical assignment
Part 5 of Class Project International Finance Dr. Xavier Garza Gomez
University of Houston-Victoria School of Business FINC 6367 International Finance Dr. Xavier Garza Gómez Spring 2019 Part 5 of the Class Project – Hedging Strategies This part of the project is worth 6 points. Students in the small groups can start working on this after Chapter 7 is covered.
Instructions Read the PDF guide labeled “Hedging Currency Exposure” and then answer the questions below. Please continue using the Excel template provided for the project. Make sure the data obtained in Parts 1 and 2 is included in the file. When you develop your formulas, please LINK the values you obtained in your data collections. Be aware that the Excel template has only a few formulas that are working. Students must check all values and calculations and derive the formula by themselves Your answer to questions 3, 5 and 6 are very important for your grade. They should reflect your understanding about the exercise. Required questions: 1. Determine the percentage change in the currency’s value over the period studied. 1a. Determine the percentage change in the futures contract over the period. Compare these two numbers. 2. Assume that on the day of DC1, you had contracted to purchase imports, which would require you to pay 1 million units of the currency on the day of DC2. (Students selecting JPY must use 100,000,000 units for this question and for the following questions)
a. If you had hedged your position with a forward hedge, how many dollars would you have paid for the goods as of the end of the period? b. If you had hedged your position with a futures hedge, how many dollars would you have paid for the goods as of the end of the school term?
c. If you had hedged your position with a call option hedge, how many dollars would you have paid for the payables as of the end of the period? Answer for the ITM, ATM and OTM call options. Please consider a cost of capital for the firm of 8% when you estimate the “total” premium paid.
Please remember that quotes for option premiums and the strike price for the options differ among currencies. Some of them will require different adjustments (divide by 1, divide by 100, divide by 1000 or divide by 10000). Be very careful when you calculate the total cost per unit.
d. Assume that you used a money market hedge at the beginning of the school term by borrowing USD at the LIBOR rate + 2%, converted into the foreign currency and invested at the LIBOR rate for the foreign currency to obtain enough money to pay for the account payable. How many dollars would you have to pay on the loan at the end of the school term?
Part 5 of Class Project International Finance Dr. Xavier Garza Gomez
e. If you did not hedge, how many dollars would you have paid for the goods as of the end of the school term?
f. Fill out the table below
Strategy used for payables Unit cost Dollar amount paid before
commissions
Total cost after considering CME fees
Forward hedge Future hedge Call options hedge (ITM) Call options hedge (ATM) Call options hedge (OTM) Money market hedge No hedge
Consider that trading one futures contract and trading one option contract costs you $7.50. In order to calculate the total commission you need to know how many contracts need to be traded. Please check the size of the futures contract and report the number of contracts required in the transaction. 3. This question connects with the forecast obtained in FXstreet.com Assume that the hedging decision depends on the forecast of the currency from FXstreet. If 100% of analysts suggest that foreign currency is going up, then you want to hedge 100% of the payables. If 100% analysts suggest that foreign currency is going down, then you will play it conservatively and only hedge 25% of the exposure. You will choose the percentage to hedge based on the percentage of analysts expecting an increase. Select the level and calculate the profit/loss for each hedging technique compared to the unhedged position (no hedge case). Which hedging alternative was best in this case? Was your forecast useful? 4. Assume that on the day of DC1, you had contracted to sell exports, which would result in your receiving 1 million units of the foreign currency on the day of DC2. (100 million for those doing the JPY) a. If you had hedged your position with a forward hedge, how many dollars would you have received for
the goods as of the end of the school term? b. If you had hedged your position with a futures hedge, how many dollars would you have received for
the goods as of the end of the school term? c. If you had hedged your position with put options, how many dollars would you have received for the
goods as of the end of the school term (account for the premium that you paid for the put option)? Answer for the ITM, ATM and OTM put options. Please consider a cost of capital for the firm of 8% when you estimate the “total” premium paid. Please remember that quotes for option premiums and the strike price for the options differ among currencies. Some of them will require different adjustments (divide by 1, divide by 100, divide by 1000 or divide by 10000). Be very careful when you calculate the net amount received per unit
d. Assume that you used a money market hedge at the beginning of the school term by borrowing foreign currency at the LIBOR rate + 3%, converted into USD and invested in the business at an annual rate of 8%. How many dollars would you “receive” at the end of the school term?
e. If you did not hedge, how many dollars would you have received for the goods as of the end of the school term?
Part 5 of Class Project International Finance Dr. Xavier Garza Gomez
f. Fill out the table below
Strategy used for receivables
Unit price Total dollar amount received
Amount received after CME costs
Forward hedge
Futures hedge
Put options hedge (ITM)
Put options hedge (ATM)
Put options hedge (OTM)
Money market hedge
No hedge
Consider that trading one futures contract and trading one option contract costs you $7.50. In order to calculate the total commission you need to know how many contracts need to be traded. Please check the size of the futures contract and report the number of contracts required in the transaction.
5. This question also connects with the FXstreet forecasts and the hedging decision depends on the percentage of analysts projecting an adverse movement.
If 100% of analysts think the foreign currency is going up, then you want to hedge the lowest amount allowed of the receivables, which is 25%. If all the forecasts suggest the foreign currency is going down, then you will definitely want to hedge 100% of the exposure. The percentage to hedge will be based on the percentage of analysts expecting an adverse movement. Select the hedging level and calculate the profit/loss for each hedging technique. Compare to the unhedged position (no hedge case) and determine what strategy was the best.
Which alternative was best in this case? Was your forecast useful?
6. What have you learned about the different hedging methods? Compare MM hedge and forward hedge. Compare forward hedge and futures hedge. Compare options and futures. Which is easier to use? Which is riskier? Which has a higher initial cost?