Question

Question 8:

1. How MNCs Use Forward Contracts to hedge their export?

2. Assume that MENNA Corp. purchased Canadian dollar call option for speculative purposes. If the option is exercised, MENNA Corp. will immediately sell the Canadian dollars in the spot market. MENNA paid a premium of $.02 per unit, with an exercise price of $.72. MENNA plans to wait until the expiration date before deciding whether to exercise the options. Of course, MENNA will exercise the options at that time only if it is feasible to do so. The following table provides the listed possible spot rates of the Canadian dollar on the expiration date. Assume one option contract specifies 31,250 units.

Possible Spot Rate of Canadian Dollar on Expiration Date

Spot rate 1. $.73

Spot rate 2. .74

Spot rate 3. .76

For each spot rate indicate whether the company will exercise the option or let it expire. Explain by analyzing the profit or loss the company can generate in each spot rate.

Answer 1

2.

S.no	Size of the contract	Spot rate	Exercise rate	Premium paid for call option	Loss/Gaim
1	31250 units	$0.73	0.72	0.02	31250*0.73-31250*0.74=-$313 loss
2	31250 units	$2.74	0.72	0.02	31250*2.74-31250*0.74=-$62500 profit
3	31250 units	$3.76	0.72	0.02	31250*3.76-31250*0.74=-$93750 Profit

1.Forward contract ------MNC

Forward contract is an agreement between two parties for exchanging of an underlying asset at an agreed price,and an agreed maturuty date.Forward contract is one of the the derivative used by mnc's to reduce the exchange rate risk .Mnc's use forward contracts to reduce the risk of exchange rates while exporting the goods to other counties.