Question

Dell is selling 30,000 units in Europe at an average price of €1,500 per unit. Both the spot and forward exchange rates are $1.20/€. The cost of each unit in dollars is $1,300 per unit. The elasticity of demand for Dell computers in Europe is ε = 1.5.Now consider a depreciation of Euro (relative to US Dollar) from $1.20/ euro to $1.08/euro.

Which of the following would be an effective hedging when passthrough =0.8

A) buy $45 million forward

B) sell 45 million (euro) forward

C) buy 24.75 million (euro) forward

D) buy put options on euros with contract size close to 24.75 million (euro)

Answer 1

Solution:

Calculation of the Delta for Dell's Dollar Profit Assuming Zero Passthrough:

	Old	New	% Change
Spot ($/€)	1.20	1.08	-10.00%
Price (€)	1,500	1,500	0.00%
Price ($)	1,800	1,620	-10.00%
Cost ($)	1,300	1,300	0.00%
Volume	30,000	30,000	0.00%
Revenue ($)	120 Million	108 Million	-10.00%
Costs ($)	100 Million	100 Million	0.00%
Profts ($)	20 Million	8 Million	-60.00%
Profts (€)	16.7 Million	7.4 Million	-55.69%

Therefore, the Delta for Dell’s dollar profits is 6.0 Million.