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

question 32

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. OTI 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:

Bronze Age

A period in human history marked by the use of bronze tools and weapons, following the Stone Age and preceding the Iron Age.

Europe

A continent located entirely in the Northern Hemisphere and mostly in the Eastern Hemisphere, characterized by its own cultural, political, and historical identity.

Americas

A term referring to the continents of North and South America collectively, along with their associated islands and regions.

Inca Empire

A large empire in pre-Columbian South America known for its advanced social, agricultural, and architectural development, centered in present-day Peru.