College BowlCollege Bowl

Round #5Round #5

Question #1Question #1

We’ve all heard of OPEC (Organization of Petroleum Exporting Countries), but very rarely do we hear about OBEC (organization of Banana exporting countries). If both of these cartels set prices worldwide in terms of dollars, who is exposed to more currency risk?

Elasticity of demand for bananas is much higher than oil. Therefore, OBEC’s sales will suffer much more than OPEC if the dollar appreciates.

Question #2Question #2

You have a payable of E 1M due in 3 months. Currently the Euro is trading at $1.30, but you are worried about a dollar depreciation. The current price of a call option on Euro (with a strike price of $1.30) is $ .05 per Euro. By how will the dollar need to depreciate to make the option hedge valuable?

By $.05 per Euro (i.e. a spot rate of $1.35)

Question #3Question #3

You have a payable of E 1M due in 3 months. Currently the Euro is trading at $1.30. You are considering two options:

1) Hedge half of the payment with a forward contract of $1.30

2) Buy a call option (at a strike price of $1.30) at a premium of $.05 per Euro.

Within what range for the spot rate is the partial hedge a better choice?

Question #3Question #3

For e < $1.30:

Price (w/partial hedge): .5(e) + .5(1.30)

Price (w/call option): e + Premium

Solve for Price (Partial Hedge) < Price (w/ call option)

For e < $1.30:

Price (w/partial hedge): .5(e) + .5(1.30)

Price (w/call option): $1.30 + Premium

Solve for Price (Partial Hedge) < Price (w/ call option)

Answer: e = [ 1.20, 1.40 ]

Question #4Question #4

Suppose that you are expecting Yen denominated sales revenues from Japan. You could hedge this by selling Yen forward or you could use the Asian money markets. What position(s) would you take in the money markets to replicate the forward hedge?

1) Borrow (short position) is Yen denominated assets

2) Convert the Yen into dollars using the current spot rate

3) Lend (long position) in US money markets

Question #5Question #5

Suppose that you have a payable denominated in Canadian dollars due in 3 months. You have a forecast of the Canadian dollar with a 95% confidence of [.75, .85]. How could you hedge this interval (and only this interval)?

Write a call option on Canadian dollars with a strike price of .85 and use the proceeds to purchase a call option with a strike price of .75.

e ($/L)

Value

.75 e ($/L)

Value

.85

Cost = $0.08/L

Value

.75e ($/L)

.85

Question #6Question #6

You have a E 100,000 payable due in 6 months. The current spot rate is $1.35, the 1 year T-Bill rate is 2% (Annual) and the annual rate on corresponding Euro assets is 4%. How much would you need to borrow today to hedge this risk through the money markets?

E100,000

1.02$1.35 = $132,353

Question #7Question #7

Suppose that you are a bank with deposits both assets and liabilities denominated in dollars AND Euro. You have difficulty predicting the direction of your currency risk, so you want to hedge in both directions. How would you do this?

Construct a straddle by buying both a call option and a put option on dollars.

Question #8Question #8

You have a manufacturing facility located in Indonesia and have a labor bill due one month from now. There are no futures contracts for Rupiahs, but you can buy Futures for Australian Dollars. Australian dollars have been negatively correlated with Rupiah in the past. What position would you take to hedge your exchange risk?

Take short positions in Australian dollar futures.

Question #9Question #9

While US sales account for 45% of Porsche sales worldwide, all Porsches are built in Eurozone countries. How does Porsche hedge their exchange exposure?

Porsche maintains a 3 year portfolio of Put options on dollars.

Question #10Question #10

In 1985, Lufthansa used a strategy of partially hedging a $500M bill for 20 Boeing 737’s. In hindsight was this the best strategy for Boeing? If no, why not?

The dollar depreciated more than Lufthansa anticipated – this made the call option hedge a more attractive strategy.

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September 12, 2001

Attacks on the World Trade Center and the Pentagon

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October 28, 2004

Red Sox win the World Series

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September 3, 2004

Bush nominated at the Republican convention

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March 20, 2003

War with Iraq begins

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February 2, 2003

Columbia explodes upon re-entry

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June 6, 2004

Ronald Reagan dies

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December 15, 2003

Saddam Hussein Captured

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November 4, 2004

Bush elected for a second term

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December 27, 2004

Tsunami hits Southeast Asia

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April 3, 2005

Pope John Paul II dies