You are required to complete a Currency Watch and Hedging project. This project is not ateam project. The project should reflect your own effort, understanding, and analytical ability. Theproject paper should not exceed five pages, excluding tables, figures, and references. The paper must be typed, double-spaced, and free of editorial errors.
Project Description. This project involves a foreign exchange rate watch over a certain period and then using available (traded or non-traded) instruments to hedge the currency exchange risk. Each student will track the changes in a foreign currency exchange rate (per U.S. dollar) for the period April 4, 2013 to June 5, 2013 as reported in The Wall Street Journal (WSJ). The students will pick a currency from the following regions: (a) Middle East, (b) Asia, (c) Latin and South America, (d) North America, and (e) Europe. Each student will submit in writing to the instructor by April 9, 2013 the currency he or she will use for the project. The selection will be on a first come, first serve basis. No more than two students can pick the same currency; preferably, each student should pick a different currency for his/her project. Your project report should include a table showing the dates and the exchange rates, a graph of the exchange rates, mean and standard deviation of the exchange rates, and two-to-three page explanation of the causes of daily exchange rate changes. You may want to track the news reported or articles published in WSJ and in other financial media about the political events, interest rates, inflation rates, estimates of growth rates in gross national product, intervention by the central bank, and money supply in both the United States and foreign country. Such information should be presumably useful in finding the causes of daily exchange rate changes. You should cite articles published in WSJ and other outlets in your explanation of variation in daily exchange rates.
In the second part of the project, you are asked to hedge the foreign exchange risk using actual data from WSJ or other online and published outlets. A U.S. firm plans to hedge on April 5, 2013 its future payment of 30 million units of the currency you picked for its planned imports from that country. The payment in the foreign currency will be made to the supplier of imports (i.e., foreign exporters) on June 5, 2013. You are asked to hedge this future payment by using alternatively futures or forward contracts (if available), option contracts (if available), and money market hedge. While there may be a single futures or forward contract traded in the first and second week of April 2013 that can be used to hedge the currency risk, there will likely be multiple option contracts (i.e., same expiration date but different exercise prices) that can meet the hedging needs of the firm. Also, use the European currency options rather than the American currency options unless no European options are traded on the currency you picked.
You are required to provide the following information/analysis in your project report:
a) Show all the necessary transactions and net cost in U.S. dollars of each hedging
b) Which technique is the best for the firm on a net cost basis? Why?
c) Compare the hedge you believe is the best to an unhedged position. Should you hedge or remain unhedged? Explain.
Use the relevant financial data from the WSJ or from other financial online and printed outlets for your hedging methods. You may use the following simplifications in your calculations for the money market hedge.
1. U.S. borrowing rate is approximated by the 90 days U.S. commercial paper rate for high grade, unsecured notes (see "Money Rates" section in WSJ).
2. U.S. investing rate is approximated by the U.S. borrowing rate minus 0.05%.
3. Foreign borrowing rate is approximated by the prime lending rate in that country or in the geographic region of that country (see "Money Rates" section in WSJ).
4. Foreign investing rate is approximated by the foreign borrowing rate minus 0.05%.
All the calculations for the project should be presented in an appendix while the final results of the three hedging techniques should be presented in tables. The descriptive or explanatory part of the report should not exceed five pages.