ir ice cream. At the current exchange rate of .989 USD to 1 Swiss franc (CHF), the cost of chocolate in francs of ₣40,317,492 comes to $39,874,000. Variations in the exchange rate will affect Ken and Terry’s earnings before tax.
a. Assume no hedge is undertaken and exchange rates may take the values of .969, .989. 1.009, and 1.029. What will be the impact on Ken and Terry’s earnings before tax with each exchange rate? (6 points)
b. You suggest a call option with a strike price of .989 and a call premium of 2.35%. Show how this will affect Ken and Terry’s cash flows. (6 points)
c. Another option is to enter into a forward contract at a forward offer rate of .999. How will this affect Ken and Terry’s cash flows? (5 points)
d. Do you recommend the call option or the forward contract? Explain. (3 points)
4. Ken and Terry’s would like to undertake a corporate value-at-risk calculation based on two risk factors of cream and chocolate. They estimate the following “returns” on these inputs by the mark-up on their finished product relative to input prices. Cream is more prevalent than chocolate; it makes up 80% of the mark-up while chocolate makes up 20%. Other data they have gathered is as follows:
Cream: expected return = 30%
variance of return = .10
Chocolate: expected return = 20%
variance of return = .06
covariance of cream and chocolate = .04
What is the largest decrease in return that Ken and Terry can expect with 99% confidence?