Final answer:
KAL can manage its foreign exchange exposure by not hedging, using a forward market hedge, or a money market hedge. The best method to maximize Korean won cash will depend on the analysis of exchange and interest rates and hedging costs.
Step-by-step explanation:
The question asks for a comparison of different ways Korea Air Lines (KAL) might manage its foreign exchange exposure. This is an aspect of financial risk management, particularly relevant to international business transactions involving currency exchange.
- a. If KAL chooses not to hedge and the spot rate in 90 days is the expected rate of KRW1199 = USD1.00, KAL will pay the same amount in Korean won at that future date as it would be based on the current expectations.
- b. With a forward market hedge, KAL would enter into a contract today to purchase dollars at a set rate that would be in effect in 90 days, effectively locking in the cost in Korean won based on that agreed rate, independent of future spot rate fluctuations.
- c. With a money market hedge, KAL would borrow the present value of the foreign currency that it needs to pay in 90 days, convert it to Korean won at the current spot rate, and invest it such that the investment matures into the exact foreign currency amount needed in 90 days.
- d. To maximize the amount of Korean won cash left in the bank at the end of the three-month period, KAL should analyze the current and anticipated future exchange rates and interest rates, as well as the cost of hedging instruments, to determine the most cost-effective method whether it be a forward contract, money market hedge, or another financial instrument or strategy.