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

question 58

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. CVT would be ________ by an amount equal to ________ with a forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had been correct.

• A) better off; $150,000
• B) better off; €150,000
• C) worse off; $150,000
• D) worse off; €150,000

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Definitions:

Labor Costs

Encompass the total expenses related to employing labor, including wages, benefits, and taxes, significant in determining product pricing and competitiveness.

Supply Management

The process of managing the flow of goods and services, from raw material sourcing to final product delivery, to maximize efficiency and minimize costs.

Transaction-Based

Referring to activities, processes, or systems that are triggered by transactions or exchanges between parties.

Process-Oriented

An approach that focuses on the processes within an organization as a means to achieve efficient results and improvement.