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Use the Information for the Following Problem(s)

question 1

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 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.

Definitions:

Interest Annually

The amount of interest earned or paid over a one-year period, often expressed as a percentage of the principal.

Economic Values

The worth of goods or services as determined by their utility and the market forces of supply and demand.

Annual Rate

A fixed percentage representing the yearly cost or return of a financial product or service.

Economic Value

The importance or usefulness of a good or service in terms of the wealth it can generate or the well-being it can provide.