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

question 44

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. The cost of a put option to CVT would be:

• A) $52,500.
• B) $55,388.
• C) $58,275.
• D) There is not enough information to answer this question.

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Definitions:

Scatterplot

A type of graph used in statistics to display and analyze the relationship between two continuous variables, with dots representing data points.

Correlation

A statistical measure that indicates the extent to which two or more variables fluctuate in relation to each other.

Weight

A measure of the heaviness of an object, often quantified using units such as kilograms or pounds.

Correlation

A statistical measure that describes the extent to which two variables change together.