Question

Instead of a traditional hedge, DKNY and the Spanish exporter agree to share the currency risks. Suppose in a price adjustment clause, the neutral zone is specified as a band of exchange rates: Euro 0.87/$ - Euro0.93/$ with a base rate of Euro 0.90/$. The exchange rate movement beyond the boundary of the neutral zone will be shared equally by two companies. If Euro depreciates to Euro 0.97/$, what is the actual dollar payment by DKNY?

Answer 1

The actual dollars are 184.78 million

Step-by-step explanation:

First, calculate the excess spread paid by the DKNY

Excess Spread = Euro 0.97/$ - Euro 0.93/$ = Euro 0.04/$

As it will be shared by two companies

Excess Spread paid by DKNY = Euro 0.04/$ x 1/2 = Euro 0.02/$

Now calculate the actual spot rate

Actual Spot rate = Base rate + Excess spread paid by DKNY = Euro 0.90/$ + Euro 0.02/$ = Euro 0.92/$

Calculate the actual payment using the following formula

Actual Payment = Payment to be made / Actual spot rate = Euro 170 million / Euro 0.92/$

Actual Payment = $184.78 million