Instruction 9.2: Use the Information for Following Problem(s)

question 13

Multiple Choice

Instruction 9.2:
Use the information for following problem(s) .
Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. 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, OTI 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
∙ OTI'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 625,000; strike price $1.42, premium price is 1.5%
∙ OTI's forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the highest acceptable purchase price for this project, is
$3,625,000 or $1.45/euro
-Refer to Instruction 9.2. The cost of a put option to OTI 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:

Information Surprises

Events or news that were unexpected by market participants, often leading to sudden changes in asset prices.

Nondiversifiable Risk

The portion of investment risk that cannot be eliminated through diversification, attributed to market factors affecting all investments.

Inflation

The upward movement in the general price index of goods and services, which diminishes the purchasing ability.

Total Return

The overall financial gain or loss on an investment over a specific period, including dividends, interest, and capital gains.