Estimating the Hedged Cost of Payables
Response to the following problem:
Grady Co. is a manufacturer of hockey equipment in Chicago, and it will need 3 million Swiss francs in one year to pay for imported supplies. The U.S. one-year interest rate is 2 percent Switzerland's one-year interest rate is 7 percent. The spot rate of the Swiss franc is $.90. The one-year forward rate of the Swiss franc is $.88. A one-year call option on Swiss franc exists with an exercise price of $.90 and a premium of $.03 per unit. As the Treasurer of Grady Co., you think the spot rate of the Swiss franc is the best forecast of the future spot rate of the Swiss franc.
a. If you use a money market hedge, determine the amount of dollars that you will pay for the payables.
b. If you use a call option hedge, determine the expected amount of dollars that you will pay for the payables (account for the option premium within your estimate).