MIB – International Financial Risk Management

Final in-class exam – 1h30

Name:
Student ID number:

Individual work

Fill everything on this paper. If needed, ask for an additional blank sheet.
You can use your class notes but no computer or phone.

Microsoft sold expensive electronics to EDF (a French company). EDF and Microsoft signed a
contract that specifies that EDF will pay € 1,000,000 to Microsoft in 180 days (upon delivery of the
electronics). Because the contract is in Euros rather than in Dollars, Microsoft is exposed to exchange
rate risk. There are several hedging alternatives to reduce the exchange rate risk arising from the sale.
To help Microsoft to make a decision, you have gathered the following currency and market quotes:
Current spot rate: $1.3872/€
Currency adviser’s forecast spot rate in 180 days: $1.3850/€
180--‐day forward rate: $1.3886/€
Company’s WACC ($) (annual rate) 7.600%
180-‐day dollar deposit rate: 2.000%
180-‐day euro deposit rate: 1.600%
180--‐day dollar borrowing rate: 2.500%
180--‐day euro borrowing rate: 2.100%

Note that all 180 day rates above are not annualized but are the corresponding rates that you would get
for 180 days.
a) What are the risks if Microsoft remains unhedged? (1.25 Points)
b) What advantages would a forward hedge provide? (describe the hedging strategy and explain
carefully the mechanism and the consequences of such hedge). (2.5 Points)
c) What advantages would a money market hedge provide? (describe the hedging strategy and
explain carefully the mechanism and the consequences of such hedge). (2.5 Points)
d) Which hedge b) or c) do you recommend and why? (1.25 Points)
e) To hedge the position of Microsoft, could you use instead a call option or a put option?
Explain carefully and give the characteristics of such option. (2.5 Points)