Question: (Hedging) You are a sales representative of an est…
(Hedging) You are a sales representative of an estonian trading company that exports mushrooms to United Kingdom. Under the terms of the contract, in one year you will deliver 80 tons (=80000kg) of mushrooms for 2,8 pounds a kilogram. Your cost of obtaining mushrooms for the mushroom pickers from Vorumaa Country is 3,40 € per kg. You may assume that all cash flows occur in exactly one year.
a) Plot (in graph) your profits in euros from the contract as a function of the exhange rate in one year, for exhange rates from 0,50€/GBP to 0,80 €/GBP (with increments of 0,10€). Label the line “unhedged profits”. Explain carefully the exposure to exhance rate risk.
b) Suppose that the current one-year forward exhange rate is 0,7 €/GBP and you consider setting up forwrd hedge. Please explain how exactly would you set up the hedge and plot your combined profits from the contract and the forward contract as a function of the exhange rate in one year. Label this line “Forward Hedge”.
c) Compare and explain your results from b with the results from a