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

question 15

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 NOT to hedge their euro payable, the amount they pay in six months will be:

• A) $3,500,000.
• B) $3,900,000.
• C) €3,000,000.
• D) unknown today

---

Definitions:

Executive Jet

A small, private aircraft used by corporations or individuals for business travel, offering speed, luxury, and convenience.

Forestalling

The act of preventing an issue or problem before it arises, often by taking preemptive measures.

Mildew-Proofing

The process or treatment involved in making materials resistant to mildew growth, typically used in textiles and building materials.

Nonverbal Communication

Unspoken communication such as physical space, appearance, handshake, and body movement.