Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for €1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in Euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. The spot exchange rate is $.8924/€ The six month forward rate is $.8750/€ Plains States’ cost of capital is 11% The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) The U. S. 6-month borrowing rate is 8% (or 4% for 6 months) The U. S. 6-month lending rate is 6% (or 3% for 6 months) December put options for €625,000; strike price $.90, premium price is 1.5% (of spot exchange rate; that is, the premium is 1.5% of spot rate per Euro) Plains States’ forecast for 6-month spot rates is $.91/€ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $.86/€ a. If Plains States chooses not to hedge their euro receivable, the amount they receive in six months will be . A. $1,125,000 B. $1,137,500 C. $1,115,500 D. undeterminable today
b. If Plains States chooses to hedge its transaction exposure in the forward market, it will €1,250,000 forward at a rate of .