In brief, you have made arrangements for the purchase of a commercial

In brief, you have made arrangements for the purchase of a commercial property in Copenhagen

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for DKK 134.00 million. The functional currency of your company is the US dollar. By

 

seeking a substantial amount of help and guidance from your real estate agent, lots of detailed

 

arrangements, including signing of the contract, computing the closing costs, funding the

 

purchase, etc., have already been taken care of. The only remaining item that is the subject of

 

this inquiry is a lump sum payment of DKK 4,500,000.00 upon the occupancy (delivery) of the

 

property, which is scheduled for three months from today.

 

Considering the variations in the currency market these days, you are very concerned that your

 

expected payment of DKK 4,500,000.00 million may impose unnecessary foreign exchange risk

 

for your company. You are considering several hedging alternatives to reduce the exchange rate

 

risk arising from this purchase. The following information is made available to you today:

 

 The spot exchange rate is DKK 5.66/$

 

 The three month forward rate is DKK 5.92/$

 

 Forecast of the management for the end of the third month is DKK 5.60/$

 

 The company’s cost of capital is 12 percent per year.

 

 The Danish 3-month borrowing or lending rate is 6 % per annum

 

 The U.S. 3-month borrowing or lending rate is 3.4 % per annum

 

 A call or put option for the strike price of DKK 5.85/$ carries a premium of 1.25 percent

 

for this period.

 

Based on the above information, first read further instructions below, then answer the ensuing

 

FIFTEEN questions (why so many? See above!).

 

1. If your company chooses to hedge this exposure in the forward market, calculate the outcome

 

of this hedge in the US dollar.

 

2. If your company chooses to hedge this exposure in the forward market, the outcome of this

 

hedge in the US dollar is certain (=1, enter 1 in the template or in the ‘transmittal form’),

 

risky (=2, enter 2 in the template or in the ‘transmittal form’), certain and risky (=3, enter 3 in

 

the template or in the ‘transmittal form’). 

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