Money Market versus Put Option Hedge
Response to the following problem:
Narto Co. (a U.S. firm) exports to Switzerland and expects to receive 500,000 Swiss francs in 1 year. The 1-year U.S. interest rate is 5 percent when investing funds and 7 percent when borrowing funds. The 1-year Swiss interest rate is 9 percent when investing funds and 11 percent when borrowing funds. The spot rate of the Swiss franc is $.80. Narto expects that the spot rate of the Swiss franc will be $.75 in 1 year.
There is a put option available on Swiss francs with an exercise price of $.79 and a premium of $.02.
a. Determine the amount of dollars that Narto Co. will receive at the end of 1 year if it implements a money market hedge.
b. Determine the amount of dollars that Narto Co. expects to receive at the end of 1 year (after accounting for the option premium) if it implements a put option hedge.