Trident’s Transaction ExposureTrident sells equipment to a British firm, Regency, for £1m, a large...

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Trident’s Transaction ExposureTrident sells equipment to a British firm, Regency, for £1m, a large sale in relation to total revenues. The contract is made in March for payment three months later. CFO would be very happy if the £ appreciated against the $ but is concerned it might fall. She budgets the minimum acceptable margin is at sales price of $1.7m. Then, she collects the following financial and market information for the analysis of her cuency exposure problem: Budget rate (lowest acceptable FX rate): $1.70/£ Spot rate: $1.7640/£ The company’s Bank is willing to buy a 3‐month forward rate: $1.7540/£ (a 2.2676% per annum discount on the pound) Trident’s cost of capital: 12.0% p.a. UK 3‐month boowing rate: 10.0% p.a. (or 2.5% per quarter) UK 3‐month investment rate: 8.0% p.a. (or 2.0% per quarter) US 3‐month boowing rate: 8.0% p.a. (or 2.0% per quarter) US 3‐month investment rate: 6.0% p.a. (or 1.5% per quarter) June put option in the over‐the‐counter (bank) market for £1m; strike price $1.75 (nearly at-the-money); 1.5% premium;   Trident’s foreign exchange advisory service forecast of 3‐month future spot rate: $1.76/£What we can say to the CFO? Online testSubject: International Financial Risk Management1 attempt , 3 questions , 2 hour time limitTiming - 12pm to 2:30 pm (IST) - 21st june

Shakeel · Accepted Answer

Answer 1
USD/EUR spot rate			1.22 EUR per USD
With the given interest rates of US = 3% and EUR = 4%
The 1-year forward exchange rate =	1.22*1.03 / 1.04 i.e. 1.2081 EUR per USD
Therefore, for no arbitrage opportunity, the exchange rate should be 1.2081 EUR per USD
To make the arbitrage profit, short position would be made on the forward rate
So, at the end of year, the USD will be purchased at 1.2081 EUR per USD and then sold at 1.21 EUR per USD.
So the arbitrage profit would be	=	(1.21 - .2081)*1,000,000
				=	$1,900
Answer 2
Receivable amount	=	100,000*1,000
			=	$100,000,000 receivable after 6 months
1.
If the receivable amount of $100 million is left un-hedged, the variation in exchange rate may reduce the total receipt at the time of realizing the money. However, there is also a possibility of gaining but the chances of loss are equally present.

Trident’s Transaction Exposure Trident sells equipment to a British firm, Regency, for £1m, a large sale in relation to total revenues. The contract is made in March for payment three months later....

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