Question

Celine Co. will need €500,000 in 90 days to pay for German imports. Today's 90-day forward rate of the euro is $1.07. There is a 40 percent chance that the spot rate of the euro in 90 days will be $1.02, and a 60 percent chance that the spot rate of the euro in 90 days will be $1.09. Based on this information, the expected value of the real cost of hedging payables is $____. A. 25,000 B. -1,000 C. 4,000 D. -35,000

Answer 1

The expected value of the real cost of hedging payables is -$35,000.

Step-by-step explanation:

To calculate the expected value of the real cost of hedging payables, we need to consider the different exchange rate scenarios and their probabilities. Given a 40% chance of the spot rate being $1.02 and a 60% chance of the spot rate being $1.09, we can calculate the expected value using the formula:

Expected value = (Probability of scenario 1 x Real cost of scenario 1) + (Probability of scenario 2 x Real cost of scenario 2)

Using the given information, the expected value of the real cost of hedging payables is calculated as:

Expected value = (0.4 x $500,000 x (1.07 - 1.02)) + (0.6 x $500,000 x (1.07 - 1.09)) = -$35,000

Answer 2

$1,000

Step-by-step explanation:

The computation of the expected value of the real cost of hedging payable is shown below:-

Real cost of hedging 1 = (€500,000 × $1.07 × (90 ÷ 360)) - (€500,000 × $1.02 × (90 ÷ 360))

= $133,750 - $127,500

= $6,250

Real cost of hedging 2 = (€500,000 × $1.07 × (90 ÷ 360)) - (€500,000 × $1.09 × (90 ÷ 360))

= $133,750 - $136,250

= -$2,500

Expected value of the real cost of hedging payable = (Real cost of hedging 1 × Spot rate Given Percentage) + (Real cost of hedging 2 × Given percentage)

= ($6,250 × 0.40) + (-$2,500 × 0.60)

= $2,500 - $1,500

= $1,000