Instruction: Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,500,000. The sale 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, Plains States 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
Plains States' cost of capital is 11%
The Euro zone borrowing rate is 9% (or 4.5% for 6 months)
The Euro zone lending rate is 7% (or 3.5% for 6 months)
The U. S. borrowing rate is 8% (or 4% for 6 months)
The U. S. lending rate is 6% (or 3% for 6 months)
December put options for euro 1,500,000; strike price $1.42, premium price is 1.5%
Plains States' forecast for 6-month spot rates is $1.43/euro
The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
What is the cost of a put option hedge for Plains States' euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.)
a) $25,328
b) $33,233
c) â¬26,728
d) â¬25,548