Question

Lorre Co. needs 200,000 Canadian dollars (C$) in 90 days and is trying to determine whether or not to hedge this position. Lorre has developed the following probability distribution for the Canadian dollar: Possible Spot Rates in 90 days Probability $.54 15% $.57 25% $.58 35% $.59 25% The 90-day forward rate of the Canadian dollar is $.585. If Lorre implements a forward hedge, what is the probability that hedging will be more costly to the firm that not hedging? Group of answer choices 75% 60% 15% 10%

Answer 1

The probability is computed as shown below:

In the case given, it is clearly mentioned that Lorre Co. locks the rate of $ 0.585 with the forward contract.

Now the possible rates in 90 days are $ 0.54, $ 0.57, $ 0.58 and $ 0.59

In the above four rates, Lorre's rates are more costly as compared with the first three rates i.e. $ 0.54, $ 0.57, $ 0.58

The probability associated with these three rates are as follows:

= 15% + 25% + 35%

= 75%

So, the probability that hedging will be more costly to the firm that not hedging is 75%

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