Use the Information for the Following Problem(s)

question 17

Multiple Choice

Use the information for the following problem(s) .
Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 3,000,000. 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, CVT 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 $1.250/euro
• The six month forward rate is $1.22/euro
• CVT'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 750,000; strike price $1.28, premium price is 1.5%
• CVT's forecast for 6-month spot rates is $1.27/euro
• The budget rate, or the highest acceptable purchase price for this project, is
$3,900,000 or $1.30/euro
-Refer to Instruction 10.2. CVT 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.

• A)better off; $150,000
• B)better off; €150,000
• C)worse off; $150,000
• D)worse off; €150,000

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Definitions:

Polygraph

An instrument used for measuring and recording several physiological indicators such as blood pressure, pulse, respiration, and skin conductivity while a subject is asked and answers a series of questions, purportedly to indicate truthfulness.

Detecting Lies

The process of identifying deceptive behavior or statements, utilizing various assessment techniques or tools.

Vasocongestion

The increase of blood flow to specific parts of the body, often causing swelling or erection of tissues.

Sexual Arousal

A physiological and psychological state of being awakened to sexual desire and readiness for sexual activity.