The following information is relevant to the next three questions:

Suppose a French firm made a sale to a Canadian company and expects to be paid $30 million in six months. The French company is concerned about the euro proceeds from international sales and would like to control its foreign exchange risk. The current spot exchange rate is $1.50/€ and six-month forward exchange rate is $1.525/€ . The French company can buy a six-month put option on Canadian dollars with a strike price of €0.65/$ for a premium of €0.02 per Canadian dollar. Currently, the relevant six-month interest rate for this company is 5 percent in the euro zone and 6 percent in Canada.

PART A

Compute the guaranteed euro proceeds to the French firm from the sale in 6 months time if it decides to hedge using a forward contract.

PART B

What would be the guaranteed euro proceeds from the sale in 6 months time if the French company decides to hedge using money market instruments and the quoted market interest rates are relevant? That is, the French firm can borrow in Canada at 6% and can invest in the French money market to earn 5%. Based on these conditions, would the forward or the money market hedge be preferred? Continuing to assuming the French firm can borrow in Canada at 6%, at what rate of return in France for the 6 months would the firm be indifferent between the forward and the money market hedge alternatives?

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PART C

If the French company decides to hedge using put options on Canadian dollars, what would be the minimum euro proceeds from the sale 6 months from now, taking the premium paid at the start into consideration and assuming it has an opportunity cost of 5%? What is the maximum euro proceeds from the sale?

Be sure to show your work!

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