Assume that Pomo Limited, a US based firm, expects to receive S$800,000 in one year. The existing spot rate of the Singapore dollar is US$0.74. The one-year forward rate of the Singapore dollar is US$0.76. Pomo created a probability distribution for the future spot rate in one year as follows:
Future Spot | Rate Probability
US$0.75 | 20%
US$0.77 | 50%
US$0.81 | 30%
Assume that one-year put options on Singapore dollars are available, with an exercise price of US$0.77 and a premium of US$0.04 per unit. One-year call options on Singapore dollars are available with an exercise price of US$0.74 and a premium of U$0.03 per unit. Assume the following money market rates:
U.S. | Singapore
Deposit rate: 9% | 6%
Borrowing rate: 10% | 7%
Given this information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate. Then compare the most appropriate hedge to an unhedged strategy, and decide whether Pomo Limited should hedge its receivables position.
a. Calculate the forward contract hedge.
b. Calculate the money market hedge.
c. Calculate the option hedge.
d. Briefly discuss the optimal hedge against the no hedge position of the company.
e. Discuss whether the multi-national corporation (MNC) like Pomo Limited will risk be over-hedged its position to the extent affect the company's financial position.