Question

On May 1. Lakin Hydraulics, a wholy owned subsary of Caterpillar (US), sold a 12 mg compression furtune to bock Tower Company of the Netherlands for 4.800.000, peable as 2.400,000 on August 1 and #2.400.000 on November 1. La derved its price quote of £4,000,000 on Apr 1 by dividing its normal US dolar sales price of $5.184,000 by the then current spot of $1.0000 By the time the order was received and booked on May 1, the euro had strengthened to $1,1300, so the sale was in fact worth 4,800.000-$1.1300/$5,424,000 Larkin had already gained an extra $240.000 from favor exchange rats movements. Nevertheless, Larkin's director of finance now wondered if the form should hedge against a reversal of the recent trend of the euro. Four approaches were possible

a. Hedge in the forward market. The 3-month foreand exchange quote was $1.1380 and the month forward quote was 1.1460
b. Hedge in the money market Lankan could bonow euros from the Frankfurt branch of a US bank at 90% per annum
c. Hedge with foreign currency optione: August put options were avalable at strike price of $1.1300 for a promium of 2.2% per contract, and November put options were available at $1.1300 for a premium of 1.4%. August options at $1.1300/ could be purchased for a premum of 3.2%, and November cell options at $1.1300/ were avalable at a 2.8% premium
d. Do nothing Larkin could wait until the sales proceeds were received in August and November, hope the recent strengthening of the eurs would continue, and sell the euros received for dolars in the spot market
Laminates the cost of equity capital to be 12% per annum. As a small from Larkin Hydraulics is unable to raise funds with long-term debt. U T-bills yield 3.8% per annum. What should Land?

Answer 1

Lakin Hydraulics should evaluate hedging options to protect against potential losses from euro exchange rate fluctuations. The decision should balance the cost of hedging against the risk of currency movements impacting profitability.

Step-by-step explanation:

On May 1, Lakin Hydraulics, a wholly owned subsidiary of Caterpillar (US), sold equipment to Bock Tower Company of the Netherlands, where currency fluctuations resulted in an additional gain of $240,000 from favorable exchange rate movements. However, due to concerns about potential exchange rate reversals, Lakin's director of finance is considering whether to hedge against the euro. The director has four hedging options: hedging in the forward market, hedging in the money market, hedging with foreign currency options, or doing nothing. The possible outcomes were illustrated by the fluctuations of the euro from 1999 to 2017. If Lakin chooses not to hedge and the euro strengthens, this could result in less favorable conversion rates when receiving sales proceeds, while a weaker euro would benefit the company.Exchange rate changes can significantly influence a company's profits, as they impact the value of international sales and costs when converted to the domestic currency.

When deciding on a hedging strategy, Lakin should assess the potential financial impact of exchange rate fluctuations on its profitability and compare the costs associated with each hedging option against the potential risks of currency movements.