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

question 53

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 locks in the forward hedge at $1.22/euro, and the spot rate when the transaction was recorded on the books was $1.25/euro, this will result in a "foreign exchange accounting transaction ________ of ________.

• A) loss; $90,000
• B) loss; €90,000
• C) gain; $90,000
• D) gain; €90,000

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Definitions:

State Laws

Laws enacted by individual states within a country, governing within their territories and subject to the constitution of that country.

Corporations

Legal entities that are separate from their owners, providing limited liability protection, the ability to raise capital through stock issuance, and perpetual existence.

Federal Security Laws

A body of laws enacted by the federal government to regulate the sale and distribution of securities to protect investors.

Debenture Bonds

A type of debt instrument that is not secured by physical assets or collateral but is backed only by the issuer's creditworthiness and reputation.