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##### Due to the rapid increase in popularity of Jet Blue,

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**Question**

Due to the rapid increase in popularity of Jet Blue, they have decided to expand their fleet. They;purchase an Airbus A380 and are billed $75 million, payable in nine months. Airbus, being a European;firm, is concerned about their current exposure to the dollar through this accounts payable to them (i.e.;they have an accounts receivable), and are interested in finding ways to hedge. They decide to explore;all options and they receive the following financial information;Spot exchange rate: $1.3540/;Nine month forward: $1.4250/;Premium on nine month put option with a strike price of 0.7500/$: 0.11/$;Nine month borrowing rate in the for Airbus: 3%;Nine month lending rate in the for Airbus: 2%;Nine month borrowing rate in the $ for Airbus: 7%;Nine month lending rate in the $ for Airbus: 6%;Compute all the following in euros with the value when the payment is received (i.e. nine months from;today).;a) What is the guaranteed revenue if Airbus decides to use a forward contract to hedge?;b) Describe a hedge using money market instruments. What is the guaranteed revenue?;c) What is the expected revenue from using options? Note here that you have to make some;assumption about what the expected future exchange rate will be. Please justify your;assumption carefully.;d) What is the future exchange rate such that the value of the accounts receivable combined with;the hedge to Airbus is equal for both the forward hedge and the option hedge?;e) How would you determine which hedge is optimal? Are there some strategies that you can;clearly rule out?;Homework 2;BUSFIN 4252;Problem 2;Hou Dealers sells fine European cars to discriminating Columbus shoppers at low, low prices, and they;are taking a shipment of 500,000 worth of BMWs in six months time and payment is due when they;receive the shipment. Since Hou Dealers revenue is all in dollars, they want to hedge their exposure to;Euros. The annual continuously compounded U.S. risk free rate is 5.5%% and the Euro risk free rate is;4.5%. Assume that they will remain constant over the next six months. The current spot rate is $1.50/.;a) If Hou wants to hedge with a forward contract, what kind of contract should they enter?;b) What is the fair price for a forward contract?;c) A month passes, the spot rate is now $1.53/. What is the value of the forward position?;Problem 3;Hou Dealers is at it again. Theyve decided to expand and are purchasing real estate in Cleveland. After;shopping around, they realize that the best deal that they can get is from a European bank, so they;borrow a five year par bound with a face value of 15,000,000 to finance their expansion at a coupon of;9.75%. They dont want to be exposed to the Euro in this way, so they enter into a swap with a swap;bank to receive 9.75% on a notional amount of 15,000,000 and are paying the bank $LIBOR + 2%, with;a principal swap at the end of the contract (so the final payment is both the principal and the final;coupon payment). Two years pass, and the fair market price of a swap is now 10.25% for a payment of;$LIBOR + 2%, the current spot rate remains unchanged from two years previous. What is the value of;the swap from the perspective of Hou dealers now?;Hint: You dont have the notional amount in dollars, but you dont need it to perform the calculation;since the exchange rate hasnt changed (and therefore, the notional amount in dollars for the new swap;hasnt changed). If you find it helpful, assume any exchange rate and work with that.;Homework 2;BUSFIN 4252;Problem 4;Hou Dealers is doing so well that they bought up Stulzs Swiss Fine Car Emporium, based in Switzerland.;They decide to let Stulzs Swiss Fine Car Emporium operate more or less independently, and they project;that every six months Stulzs Swiss Fine Car Emporium will remit SFr12,500,000 going forward;indefinitely. Hou wants to manage this exchange rate risk, and they decide a swap is the best way to go;due to the perpetual and fixed nature of the receipts from Stulzs Swiss Fine Car Emporium. They take a;look in the paper and discover that the current exchange rate is SFr1.5/$.;After talking with a swap bank, they receive the following quotes for an interest only swap in perpetuity;7.5% per year on a notional amount of $ in exchange for LIBOR on a notional amount of dollars;6.5% per year on a notional amount of SFr in exchange for LIBOR on a notional amount of;dollars.;Note that there is no bid-ask spread for the swaps.;a) Does a swap make sense as a way to hedge this currency risk? (Hint: the answer is yes) Why?;How would you use a swap to hedge this currency risk?;b) What notional amounts should both the $ and the SFr portions of the swap be written on?;c) What are the cash flows?

Paper#30189 | Written in 18-Jul-2015

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