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**Chapter 10** No. 23 As the new amusement park is built and operated in France, the revenue generated are measured and collected in euros. When the value of euros is depreciating in the long run against the US dollars, the Walt Disney Company, whose headquarter is in the US, would receive fewer dollars from the amusement park in France. This is how exchange rate would affect the cash flows of the company, so the companys exposure to exchange rate movements would be larger. In addition to affect brought by the currency exchange rate, the operation of amusement park in France can hedge the risk of declining revenue in the US. When the value of US dollars is appreciating against euros, the customers would spend more to visit a park in the US compared to that in France, and thus the cash flow generated by French park would increase to compensate the decline cash flows generated by US park.

No. 28 To measure the exchange rate risk, we need to calculate the standard deviation and VaR of each currency and then the SD of each company. First, the rate of change of 5 months are (0.8176-0.8142)/0.8142=0.418%, (0.8395- 0.8176)/0.8176=2.679%, (0.8542-0.8395)/0.8395=1.751%, 0.8501-0.8542)/0.8542=-0.48% and 0.8556-0.8501)/0.8501=0.647%, respectively. Then the average rate of change is (0.418%+2.679%+1.751%-0.48%+0.647%)/5= 5.015%/5 = 1.003%. Therefore, the standard deviation of Canadian dollars is {[(0.418%-1%)^2+(2.679%-1%)^2+(1.751%-1%)^2+(-0.48%- 1%)^2+(0.647%-1%)^2]/(5-1) }^0.5=1.23%. The VaR = 0 – (1.23 * 1.65) = -2.03%. Similarly, we can obtain the SD and VaR of Mexican Peso of 0.0157 and -2.59%, respectively and the SD and VaR of Polish Zloty of 0.016 and -2.64%. Then, given in the question, the SD and VaR of Vermont Co. is 0.01 and – 1.65%, which is lower than that of Washington Co. Therefore, Washington Co. has a higher degree of exchange rate risk.

No. 34 As given in the question, the spot rate of Canadian Dollar is $0.60 while the spot rate of Peso is $0.10. Also, the earning of Kanab Co. in the first year is 20+1 = C$21 million while change in spot rate at the end of year is 0.60*0.08 = C$0.048. Then, the total change in value of earning = 21*0.048= $ 1.008 million Similarly, for Zion’s, the change in value of earning is (1+300) * 0.10*0.12 = $3. million, which is a lot lower than the change of Kanab Co. The trend would last for four more years, so Zion’s co. has lot higher degree of translational exposure when compared to Kanab’s Co.

No. 36 Given in the question, the regression model can be rewritten as the following: = 0. 4 + Therefore, there is an inverse relationship between the percentage change in Spratts stock price and pound value. As the British interest rate is higher than the US interest rate, and based on the interest rate parity, the forward rate of pound would decrease, and thus the pound value would decrease as a result. Back to the regression model, the Spratts stock price would be expected to increase so the Spratts value is favorably affected.

Small Business Dilemma a) In this case, the exchange rate movements would affect value of the firms contractual transactions in foreign currencies, so the company has transaction exposure. At the same time, the companys cash flow is also affected by the exchange rate movement, the company also has economic exposure. b) No, as the importer is operating its business using pounds and will need to convert the pounds into dollars and then pay Logan. The number of US dollars received by Logan is still fluctuated with the value of pounds, so the economic exposure is not eliminated while transaction exposure is also not eliminated as the policy does not fundamentally change the effect brought by exchange rate movements. c) The new policy would have the same effect as the original policy. As the pound depreciates against dollars, the cost of export would increase and the sales would decrease, so the total amount of cash flows has not changed. Also, when the pound appreciates against dollars, the cost of export would decrease and the sales would increase, keeping the cash flows same.

**Chapter 11**

No. 33 a) Using the put option. Given in the question, the three possible spot rates are 0.50, 0.51 and 0.52 with the option premium of 0.03, 0.03 and 0.03 respectively. Therefore, the company would decide to exercise the first two option but not the third one. Then the company would receivable per unit after accounting for the premium are 0.49 0.49 0.50. The total dollars received by converting 4 million NZD are 1,960,000, 1,960,000 and 2,000, with the probability of 0.2 0.5 0.3, respectively. Therefore, the expected value of cash to be received is 1,960,000*0.2+1,960,000*0.5+2,000,000*0.3=1,972,000.

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b) Using money market hedge.
Firstly, the company needs to borrow face value of 4 million NZD with borrowing rate of
8% so getting 4,000,000/1.08=3,703,704 NZD. Then convert NZ 3,703,704 to $2,000,
at the exchange rate of 0.54 NZD/USD and invest $2,000,000 with the interest rate of
9% to get $2,180,000 after one year, which is higher than the expected value of cash
using the put option.
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Therefore, money market hedge would be a better option for the company to hedge this position.

No. 41 As given in the question, the existing spot rate is $.62 while the one-year forward rate is $.64, and Denver Co. has submitted an order for three loads of supplies, which will be priced at C$3 million. Therefore, the total US dollars needed is 3,000,000*. 64 =$1, 920 , 000 which is a cash outflow. The amount of Canadian dollars left 1 load of supplies is C$2,000,000, the the company would have a cash inflow if 2,000,000 * 0.59=$1,180,000. Then the net cash flow is $1,180,000 – $1, 920 , 000 = – $740,000, which is a cash outflow of 740,000 in USD.

No. 45 a) To construct a bull spread using the first two options, the company needs to long the first potion and short the second option. As the premium of the first and second option are $0.03 and $0.01, respectively, the company would pay the spread of $0.0 3 – $0.01=$0.02 for each SF. Therefore, the company would pay $0.02*62,500=$1,250. The hedge would effective when the future spot rate of franc is between 0.74 and 0. where the company can benefit from two options. The hedge would be ineffective when the future spot rate exceeds the 0. 77 where the company can more buy the first option to hedge. b) To construct a bull spread using the first and the third option, the company needs to long the first potion and short the third option. As the premium of the first and third option are $0.03 and $0.0 06 , respectively, the company would pay the spread of $0.0 3 – $0.0 06 =$0.02 4 for each SF. Therefore, the company would pay $0.02 4 *62,500=$ 1 , 50 0. The hedge would effective when the future spot rate of franc is between 0.74 and 0. 80 where the company can benefit from two options. The hedge would be ineffective when the future spot rate exceeds the 0.8 where the company can more buy the first option to hedge. c) By comparing the two bull spreads, we notice that the bull spread with a higher exercise price would a lot more expensive while the range of effective hedge would be larger in this case, indicating higher probability of being effective. The tradeoff is between price and range of effective range.

No. 46 a) The company could construct a bear spread by shorting the option with 0.72 exercise price and long the option with 0.74 exercise price. b) As the spot rate of the Canadian dollar in one month is 0.73, the hedge is effective. If the company decides not to use the bull spread, the company will receive the cash flow if C$50,000*0.73=$36,500. The company would short the option with 0.72 exercise price with premium of 0.03 and long the option with 0.7 4 exercise price with premium of 0.01. The company would receive (0.03-0.01)*C$50,000=$1,000. Given the spot rate, the buyer of option with 0.72 would choose to exercise the option and the company

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needs to sell the receivables. The net cash flow would be C$50,000*0.72+1000=$37,000,
which is higher than $36,500. Therefore, the hedge is effective.
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No. 48 To construct a long strangle, Brooks need to long 4 call option and long 4 put option with different exercise prices. Brooks need to pay 2 million*(0.002+0.001)=$6,000 which is lower than using a long straddle of 2 million*(0.00 3 +0.00 2 )=$ 10 ,000. The advantage of using long strangle strategy would be more cost effective. At the same time, the long strangle would not effective if the spot rate is deviating from the exercise prices. If the spot rate is within the range of 0.09 and 0.105 at maturity, the strangle would not be exercised. Brooks is already hedge outside of this range as it would not have to pay more than 0.105 and can sell for more than 0.09.

No. 52 a) The company needs to borrow the face value of 500,000 SF with borrowing rate of 11%, so the company will get francs of 50 0 ,000/(1+11%)= SF450,450. Then the company convert SF into USD at the exchange rate of $0.8 so company will receive 450,450*0.8=$360,3 60 .36 and invest with interest rate of 5% and will get $360,3 60 .36*(1+5%)=$ 378 ,378.38. b) As the exercise price is 0.79, the company can choose to exercise the put option by paying the premium of 500,000*0.02=10,000 and sell francs at the exercise price of 500,000*0.79=$395,000. The net cash flow of this would $395,000-$10,000=$385,000.