question archive Lucky 13 Jeans of San Antonio, Texas, is completing a new assembly plant near Guatemala City
Lucky 13 Jeans of San Antonio, Texas, is completing a new assembly plant near Guatemala City
Subject:FinancePrice:2.87 Bought8
Lucky 13 Jeans of San Antonio, Texas, is completing a new assembly plant near Guatemala City. A final construction payment of Q8,400,000 is due in six months. ("Q" is the symbol for Guatemalan quetzals.) Lucky 13 uses 20% per annum as its weighted average cost of capital. Today s foreign exchange and interest rate quotations are as follows: Construction payment due in 6 months (A/P, quetzals)...............8,400,000 Present spot rate (quetzals/$)...............................................7.0000 6-month forward rate (quetzals/$).........................................7.1000 Guatemalan 6-month interest rate (per annum)........................14.000% U.S. dollar 6-month interest rate (per annum)..........................6.000% Lucky 13 s weighted average cost of capital (WACC).............20.000% Lucky 13 s treasury manager, concerned about the Guatemalan economy, wonders if Lucky 13 should be hedging its foreign exchange risk. The manager s own forecast is as follows: Highest expected rate (reflecting a significant devaluation)...........8.0000 Expected rate.................................................................7.3000 Lowest expected rate (reflecting a strengthening of the quetzal).....6.4000 What realistic alternatives are available to Lucky 13 for making payments? Which method would you select and why?
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Answer:
Amount to be paid under No hedging
Construction payment due in six months (A/P, quetzals) = 8,400,000
Six-month forward rate (quetzals/$) = 7.1
Amount to be paid after six month = 1183098
Alternative= Money market hedge
Amount of Q to be invested today in Guatemalan quetzals money market @ 14% p.a. for 6 months = 8400000 / (1 + 1*14%*0.5) = 7850000
Spot rate = 7
Amount of $ to be borrowed today in order to purchase Q 785000 today at spot rate= 1121428
Add- interest payable for 6 month = 33642
Amount to be paid at end of 6 month = 1155070
Gain from money market hedging = 1183098 = 1155070 = 28028
