Exam 10: Transaction Exposure

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 10.1.If CVT chooses NOT to hedge their euro payable,the amount they pay in six months will be:

There are as many different approaches to foreign exchange transaction exposure management as there are firms and no real consensus exists regarding the best approach.List and discuss three different exposures you can hedge and three different types of hedges (for example option hedges versus non-option hedges).

________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.

Losses from ________ exposure generally reduce taxable income in the year they are realized.________ exposure losses are not cash losses and therefore,are not tax deductible.