Assignment: Analyze each of the alternatives below, and then choose one as your suggested hedging strategy. (Assume a 365 day year for all calculations.) The possible
hedging choices are:
a) Remain unhedged. Evaluate the risks and results of this strategy ($ cost of jets) if the $/€ turns out to be 1.00, 1.05, 1.10, 1.15, 1.20.
b) State Street forward hedge. Explain the implementation of this hedge and the cash flows at maturity. What is the exchange rate that JetBlue would have to pay if
they used this alternative?
c) Money market hedge. Explain the implementation of this hedge and the cash flows at maturity. What is the effective exchange rate that JetBlue would have to pay
if they used this alternative?
d) Currency Futures hedge. Explain the implementation of this hedge and the cash flows at maturity. What is the exchange rate that JetBlue would have to pay if they
used this alternative?
e) BNYM option hedge.
a. Use the Black-Scholes model to confirm if the BNYM premiums are reasonable. In other words, what combinations of the given strike prices, maturity, volatility, spot bid/ask, and the USD LIBOR/Euro LIBOR rates would generate the call and put premiums, with screenshots of the option pricing model.
b. Evaluate historical volatility over 3 months and 1 year. http://www.investopedia.com/ask/answers/021015/how-can-you-calculate-volatility-excel.asp
c. Look online/Bloomberg for current quotations of one year $/€ volatility.
d. Based upon what you found out about volatility (above), are the BNYM options fairly priced?
e. Decide whether the BNYM call or put is the appropriate strategy. Evaluate the overall hedged results of this strategy ($ cost of jets) if the $/€ turns out to be 1.00, 1.05, 1.10, 1.15, 1.20, noting in what cases the option is exercised or not.
f) Synthetic option hedge
a. A synthetic option is where JetBlue can buy the delta-equivalent of the above option strategy, and adjust this position given future price movements. To execute
on this strategy, what initial position would JetBlue take? Under what circumstances might this be preferable to the actual option strategy?
Deliverable: In an MSWord document with no quotations, the following section headings are suggested:
– Introduction of the problem
– Analysis of each hedging alternative with valuations and risks/reward
– Recommendation
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