Use the Information for the Following Problem(s)

question 40

Multiple Choice

Use the information for the following problem(s) .
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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 $1.40/euro
∙ The six month forward rate is $1.38/euro
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
-Refer to Instruction 10.1.Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate.The payoff in 6 months will be ________.

• A)$1,750,000
• B)$1,250,000
• C)$1,725,000
• D)$1,787,500

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Definitions:

Correlation

A statistical measure that describes the extent to which two or more variables fluctuate together.

44° Angle

An angle that measures 44 degrees, representing a specific amount of rotation between two lines around their common point.

Best Fit

A line or curve that approximates the relationship between two variables in a set of data, minimizing the discrepancies between observed and predicted values.

Data Points

Individual values or measurements that are collected as part of a data set.