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On 1^st March 2022, the US subsidiary of Greenfields plc signed a contract to sell two batches of seed drills to Jordanian company Palermo Plc for JD12,000,000, with JD7,000,000 payable on 1^st June 2022 and JD5,000,000 on 1^st September 2022. The US subsidiarys director of finance now wonders if the company should hedge against a reversal of the recent trend of the Jordanian Dinar. The current spot rate is $1.10/JD.

The US subsidiary has three hedging alternatives available:

a) Hedge in the forward market. The 3-month forward exchange quote is $1.1060/JD, the 6-month quote was $1.1130/JD, the 9-month quote was $1.1134/JD, and the 12-month quote was $1.1138/JD.

b) Hedge in the money market. The company could borrow Jordanian Dinars from the Munich branch of Deutsche Bank at 8%

c) Hedge with foreign currency options. June put options are available at a strike price of $1.13/JD for a premium of 2% per contract and September put options are available for the same strike price of $1.13/JD at a premium of 1.2%. June call options are available at strike price of $1.1000/JD for a premium of 3% per contract, September call options are available at strike price of $1.1000/JD for a premium of 2.6%.

The US subsidiary has a cost of capital of 12%.

Required:

B1) Indicate the factors that influence changes in exchange rates between currencies. Describe a theory to estimate future spot rates.

B2) Calculate the expected US$ value of the contract based on:

1. Forward contract
2. Money market hedge
3. Foreign currency options

B3) Advise the US subsidiary of Greenfields plc on the hedging strategy that should be adopted for the contract with Palermo Plc based on your analysis.

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