SMALL BUSINESS DILEMMA
Hedging Decisions by the Sports Exports Company
Jim Logan, owner of the Sports Exports Company, will be receiving about 10,000 British pounds about 1 month from now as payment for exports produced and sent by his firm. Logan is concerned about his exposure because he believes that there are two possible scenarios: (1) the pound will depreciate by 3 percent over the next month or (2) the pound will appreciate by 2 percent over the next month. There is a 70 percent chance that (1) will occur. There is a 30 percent chance that (2) will occur. Logan notices that the prevailing spot rate of the pound is $1.65, and the 1-month forward rate is about $1.645. Logan can purchase a put option over the counter from a securities firm that has an exercise (strike) price of $1.645, a premium of $.025, and an expiration date of 1 month from now.
1. Determine the amount of dollars received by the Sports Exports Company if the receivables to be received in 1 month are not hedged under each of the two exchange rate scenarios
2.the amount of dollars received by the Sports Exports Company if a put option is used to hedge receivables in 1 month under each of the two exchange rate scenarios.
3. Determine the amount of dollars received by the Sports Exports Company if a forward hedge is used to hedge receivables in 1 month under each of the two exchange rate scenarios
. 4. Summarize the results of dollars received based on an unhedged strategy, a put option strategy, and a forward hedge strategy. Select the strategy that you prefer based on the information provided