Instruction 11.2:Use the Information for the Following Problem(s)

question 27

Multiple Choice

Instruction 11.2:Use the information for the 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 11.2. If OTI chooses NOT to hedge their euro payable, the amount they pay in six months will be ________.

• A)$3,500,000
• B)$3,450,000
• C)€3,450,000
• D)unknown today

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Definitions:

Neutrons

Subatomic particles present in the nucleus of an atom, having no electric charge.

Hydrogen Bond

A feeble connection formed between two molecules through the electrostatic force that attracts a proton in one molecule to an electronegative atom in the other.

Covalently Bonded

Refers to atoms connected by the sharing of pairs of electrons, creating a stable arrangement of atomic components.

Attraction

The force or influence that draws objects or individuals together.