Question

Company A, is a participant in both the currency and petrochemical markets. Although it is a Norwegian company, because it operates within the global oil market, it considers the U.S. dollar($), rather than the Norwegian krone (Nok), as its functional currency. Answer the following:

a ) Company A sold 1 million barrels of oil to a Norwegian petrol station, today for 120 Nok per barrel. Company A expects to receive the full payments from the petrol station in 3 months’. Company A is informed that the petrol station will pay for the oil in Norwegian Krone. Company A wants a strategy to reduce the uncertainty around the expected payment from the petrol station. Company A is faced with the following market rates:

Spot exchange Rate Nok 6.0312/$

3-month forward rate Nok 6.0186/$

U.S. dollar 3-month interest rate 5%

Norwegian Krone 3-month interest rate 4.45%

Based on the above info, what hedging strategy works the best for Company A? Explain why Company A should choose such hedging strategy. How much U.S.dollar will Company A receive at the end of 3 months by using this hedging strategy?

Answer 1

Sales value = 1 million barrels *120NOK/barrel i.e.120 million Nok

Company A will received the payment after 3 month so he should sell today at 3 month forward rate .A should choose heding to protect from fall in price of Nok.

Sale Forward today dollar received today= 120 million Nok/NOK6.0186 i.e.$19.938 million

Invest this amount for 3 month at 5% p.a , Interest recived after 3 month =19.938 million*5%*3/12 i.e.$0.249225 million

Total dollar receivable at end of 3 month = 19.938 million +0.249225 million i.e.$20.177255 million.