Question

Najafi Company. Najafi Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was 7,600 million Korean won (KRW). KRW 1,000 million has already been paid, and the remaining KRW6,600 million is due in six months. The current spot rate is KRW1,120 = USD1.00, and the 6-month forward rate is KRW 1,161 = USD1.00. The 6-month Korean won interest rate is 15.5% per annum, the 6-month U.S. dollar rate is 5% per annum. Najafi can invest at these interest rates, or borrow at 2% per annum above those rates. A 6-month call option on won with a KRW 1,200= USD 1.00 strike rate has a 4.1% premium, while the 6 -month put option at the same strike rate has a 3.5% premium. Najafi's weighted average cost of capital is 10.5%. Compare alternate ways below that Najafi might deal with its foreign exchange exposure.

a. How much in U.S. dollars will Najafi pay in 6 months without a hedge if the expected spot rate in 6 months is assumed to be KRW1,120 = USD1.00? KRW1,161 = USD1.00?
b. How much in U.S. dollars will Najafi pay in 6 months with a forward market hedge?
c. How much in U.S. dollars will Najafi pay in 6 months with a money market hedge?
d. How much in U.S. dollars will Najafi pay in 6 months with an option hedge if the expected spot rate in 6 months is assumed to be less than KRW1,200 = USD1.00? To be KRW1,300 = USD1.00?
e. What do you recommend?

Answer 1

Najafi would pay approximately $6.785 million without a hedge if the expected spot rate is KRW1,120 = USD1.00, $6.54 million if the expected spot rate is KRW1,161 = USD1.00, $5.68 million with a forward market hedge, and $6.59 million with a money market hedge.

Step-by-step explanation:

To calculate the amount of U.S. dollars Najafi will pay in 6 months without a hedge, we need to consider two scenarios: the expected spot rate being KRW1,120 = USD1.00 and KRW1,161 = USD1.00. For the first scenario, Najafi will pay approximately $6.785 million, and for the second scenario, they will pay approximately $6.54 million.

To calculate the amount of U.S. dollars Najafi will pay in 6 months with a forward market hedge, we consider the forward rate of KRW1,161 = USD1.00. Najafi will pay approximately $5.68 million.

To calculate the amount of U.S. dollars Najafi will pay in 6 months with a money market hedge, we need to consider the interest rates. Assuming a 6-month rate of 15.5% for Korean won and 5% for U.S. dollar, Najafi will pay approximately $6.59 million.