Question: ABC Corporation has 90-day receivables of Euro 500,000. The following information is available:
Spot rate of the Euro: $ 1.20 per Euro
90-day Forward Rate: $ $1.15 per Euro 90-day
Interest rates are as follows: US Euro
90-day deposit rate 5.0 % 5.0 %
90-day borrowing rate 7.0 % 7.0 %
A call option on Euro that expires in 90-days has an exercise price of $1.20 and has a premium of $ 0.03. A put option on Euro that expires in 90-days has an exercise price of $1.20 and has a premium of $0.02
The Euro spot rate in 90-days is forecasted to be:
Possible Rate Probability
$1.15 30 %
$1.10 70 %
ABC Corporation is considering:
a) A forward hedge
b) A money market hedge
c) An option hedge and
d) Remaining un-hedged
You have been hired as a consultant to decide on the best possible hedge. Which one of the alternatives you will recommend, and why?