Suppose that Baltimore Machinery sold a drilling machine to a Swiss firm and gave the Swiss client a choice of paying either $10,000 or SF 15,000 in three months.
a) In the above example, Baltimore Machinery effectively gave the Swiss client a free option to buy up to $10,000 dollars using Swiss franc. What is the ‘implied' exercise exchange rate?
b) If the spot exchange rate turns out to be $0.62/SF, which currency do you think the Swiss client will choose to use for payment? What is the value of this free option for the Swiss client?
c) What is the best way for Baltimore Machinery to deal with the exchange exposure?