Finance question
You are a broker for frozen seafood projects for Choyce Products. You just signed a deal with a belgian distributor. Under the terms of the contract, in one year you will deliver 4,000 kg of frozen king crab for 100,000 euro. Your cost for obtaining the king crab is $110,000. All cash ?ows occur in exactly one year.
(a): Plot your pro?ts in one year from the contract as a function of the exchange rate in one year for exchange rates from USD/EUR $0.75 to $1.5. Label the line "Unhedged pro?ts"
(b): Suppose the one year forward exchange rate is $1.25 USD/EUR and that you enter into a forward contract to sell the euros you receive at this rate. In the ?gure from part (a), plot your combined pro?ts from the crab contract and the forward contract as a function of the exchange rate in one year. Label the line "Forward hedge."
(c): Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy euros at a strike price of $1.25 is trading for $0.10 per euro. Similarly, a one year put option to sell euros at a strike price of $1.25 is trading for $0.10 per euro. To hedge the risk of your pro?ts, should you buy or sell the call or the put?
(d): In the ?gure from parts (a) and (b) plot your "all in" pro?ts using the option hedge (combined pro?ts of crab contract, option contract, and option price) as a function of the exchange rate in one year. Label this line "Option Hedge" (note: you can ignore the e?ect of interest on the option price).