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Instruction 10.1: Use the Information for the Following Problem(s)

question 50

Multiple Choice

Instruction 10.1:
Use the information for the following problem(s) .
Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Germany for €3,000,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.250/euro
• The six-month forward rate is $1.22/euro
• CVT's cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December call options for euro 750,000; strike price $1.28, premium price is 1.5%
• CVT's forecast for 6-month spot rates is $1.27/euro
• The budget rate, or the highest acceptable purchase price for this project, is $3,900,000 or $1.30/euro
-Refer to Instruction 10.1. If CVT chooses to hedge its transaction exposure in the forward market, it will ________ €3,000,000 forward at a rate of ________.

Definitions:

Null Hypothesis

A statistical hypothesis that assumes no significant difference or effect in a given set of observations.

Point Estimate

A single value or statistic that serves as the best guess or best estimate of an unknown population parameter.

Population Proportion

The fraction of members in a statistical population that meet a specified characteristic or criteria, often estimated using sample data.

Defective Items

Products that fail to meet quality standards or specifications and are therefore unsuitable for sale or use.