Following the international expansion Barta PLC has grown into a successful multinational company
Following the international expansion Barta PLC has grown into a successful multinational company with subsidiaries in various countries and territories including Barbados, Grenada, the US, Italy, etc. The company operates a centralised treasury management system from London.
On 1st March 2021, US subsidiary of Barta PLC signs a contract to sell two batches of 5G towers to French company Nice ltd for €10,000,000, payable €5,000,000 on 1st June and €5,000,000 on 1st September 2025. The US subsidiary’s finance director is considering hedging options to manage exposure to exchange rate risk. Current spot rate is $1.10/€.
Three hedging alternatives were possible for the US subsidiary:
a) Hedge in forward market. The 3-month forward exchange quote was $1.1060/€, the 6-month quote was $1.1130/€, the 9-month quote was $1.1134/€, and the 12-month quote was $1.1138/€.
b) Hedge in the money market. The company could borrow euros from the Munich branch of HSBC at 8%
c) Hedge with foreign currency options. June put options were available at strike price of $1.1500/€ for a premium of 2% and September put options were available for the same strike price of $1.1500/€ at a premium of 1.2%. June call options were available at strike price of $1.1500/€ for a premium of 3% per contract, September call options were available at strike price of $1.1500/€ for a premium of 2.6%.
The US subsidiary estimates its cost of capital to be 12%.
1) Calculate the expected US$ value of the contract based on:
a) Forward contract
b) Money market hedge
c) Foreign currency options
2) Advise US subsidiary of Barta PLC on the hedging strategy that should be adopted for the contract with Nice Ltd based on your analysis.