You have the opportunity to exercise a call option on EUR (Euros) from a German company. The exercise price is $1.75, with a $0.04 per unit premium and a 60-day expiration date.
A put option is also available that has an exercise price of $1.75, a premium of $0.03, and a 60-day expiration date.
Your plan is to purchase options to cover your future receivables of 650,000 EUR in 60 days. If you exercise the option, it will be in 60 days and the expected spot rate is expected to be $1.68 at that time. What will be the USD received after all costs?
Part Two: Foreign Operations
Garth, Inc. operates in two countries: the U.S. and Germany. The company is based in the United States and all profits are submitted to the U.S. base at the end of each year. Exchange rates have been volatile in recent years and you have estimated that the exchange rate for the coming year could be as follows:
EUR = $0.65
|EUR = $0.70|
|EUR = $0.75|
|EUR = $0.80|
You also have gathered the following information for the two entities:
|U.S. Operations (in USD)||German Operations (in EUR)|
Your major concern is about how the German business is affecting the cash flow for the company.
- How is the German operation affecting the cash flows of the company, ignoring any tax effects?
- Would you recommend that Garth drop the German operation? Why or why not?
Part Three: Currency Trading
Your company would like to take advantage of an opportunity to invest in foreign currency, specifically, the Japanese Yen (JPY). Your boss has assigned this analysis to you since you just graduated with a degree in international finance.
You believe that the Yen will appreciate from $1.20 to $1.25 over the next 7 days. You have researched the market and found that interest rates in the U.S. are 6.5% lending rate and a 7% borrowing rate. In Japan, the lending rate is 6% and the borrowing rate is 6.25%.
- If your company borrows the cash to conduct the transaction over the next 7 days, what will be your dollar profit/loss if the investment requires $100,000?
- If your company borrows $50,000 and uses its own cash for the remaining $50,000, what will be the dollar profit/loss?
- What would be the pros and cons of borrowing or not to borrow in order to make the investment?
- Would you recommend the investment? Why or why not?
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