New Tech Corporation is based in Warwick, U.K. The Corporation will sell a network monitoring system to Open Telecom Group. The system costs US$50,000,000 and will be paid by Open Telecom Group in six-months. New Tech Corporation plans to control any exchange rate risk incurred from this transaction. To hedge the exchange rate risk, New Tech Corporation buys a six-month put option on US dollars, with a strike price £0.80/US$ for a premium of £0.06/US$. At the moment, the spot exchange rate is US$1.3220/£ and the six-month forward rate is US$1.5235/£. Assume the six-month effective interest rate in U.K. is 0.5% per annum and in U.S. is 1.5% per annum.
(a) If New Tech Corporation uses money market instruments to hedge exchange rate risk, elaborate how the Corporation implement and assess the sterling proceeds incurred.
(b) New Tech Corporation treats the forward exchange rate as an unbiased predictor of the future spot exchange rate, what would be the proceeds this time with using put options on US dollars?
(c) Jeff is the financial manager of New Tech Corporation, he stated that there will be no difference between the option and money market hedge for the corporation. Explain and analyze Jeff’s belief. Provide any necessary calculation.