Use the Information for the Following Problem(s)

question 27

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 9.1. 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:

Reduction of Information

The process of simplifying or consolidating information to make it more understandable and manageable.

Bodily Kinesthetic

Refers to a learning style that involves the use of body movement and the ability to process information through physical sensations.

Affective

Refers to moods, feelings, and attitudes, especially as they influence behavior or learning.

Evaluative

Involving making judgments about the value of something, typically in terms of its usefulness, quality, or performance.