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As you know, Yoda Corporation, a division of Blackthorn imports goods from New Zealand, and plans to purchase NZ$ 10,000,000 of goods one quarter from now. You have already run several regressions for them in the regression case. Now the Treasurer of Blackthorn wishes you to develop forecasts to use to decide on appropriate hedging strategies for the purchase using revised data.
|Quarter||90 day forward beginning of Quarter||Spot rate Beginning of Quarter||Spot rate end of quarter||Last Quarters inflation Differential %||Prior % change in exchange rate|
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You are tasked with using regression to assess three different hypothesizes to forecast the value of the NZ$ at the end of the quarter (FSR the future spot rate), and then using those to determine an optimal hedging strategy.
- FSR is determined by the Forward rate at the beginning of the quarter
- FSR is determined by the spot rate at the beginning of the quarter.
- Estimating the relationship between the inflation differential during each quarter and the percentage change in the NZ$. Then using an estimate of the current inflation differential, predict the expected percentage change (using equation below) and then use that % change to modify the current spot to determine FSR.
Expected percentage change in NZ$=a+b*(Last Q inflation diff)
- The treasurer plans to develop a probability distribution for FSR. First it will assign a 40% probability to the forecast based on inflation differential, 40% based on the forecast that was most successful in meeting the requirements for a “good regression” from the forward and spot regressions, and 20% on the least accurate of those two regressions.
- Then complete the following table
|Probability||FSR $/nz$||payments if no hedge||amount need if Forward hedge||Real Cost Hedge||Regression used|
- What is the expected cost of not hedging versus the forward hedge?
- Other than the forward hedge, Blackthorn can use a money market hedge or a call option to hedge. From the data below, determine the probability distribution of the dollars needed for a call option if used (include the premium paid) by filling out the following table.
|Probability||FSR $/nz$||will you expect to exercise given exercise price $.60||what it costs per unit||$needed including premium (rate + Premium)|
Data: 90-day U.S. borrowing rate =2.5%
90 day U.S. investing rate= 2.3%
90 day New Zealand borrowing rate =2.4%
90 day New Zealand investing rate= 2.1%
Call option on NZ$ has premium of .01 per unit
Call option on NZ$ has an exercise price of $.60
- Compare the forward hedge to the money market hedge. Which is superior? (compute both)
- Compare the superior hedge in 9, to the option hedge. Which is superior?
10.Compare the hedge you believe is best to the unhedged strategy? Should you hedge?
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