) TO IMPLEMENT CLIENT F'S REQUEST, ALLISON'S MOST APPROPRIATE COURSE...

6.) To implement Client F's request, Allison's most appropriate course of action is to: A. sell U.S. Treasury bond futures contracts and buy S&P 500 Index futures contracts. B. buy U.S. Treasury bond futures contracts and buy S&P 500 Index futures contracts. C. buy stocks in the S&P 500 Index and sell U.S. Treasury bond futures contracts. Montero Pascal Montero is the director of the treasury department of the Viewmont Corporation, which is based in Chicago, Illinois. Viewmont manufactures steel and aluminum food cans in plants located in the United States and Brazil. Generally, raw materials are sourced from suppliers located in the country where the plant is located. But when shortages occur at a particular location, Viewmont imports raw materials. Montero’s duties include procuring financing and managing interest rate and currency risk for Viewmont. Montero is meeting with two of his senior analysts, Maissa Bazlamit and Jacky Kemigisa, to plan the company’s hedging and financing activities. Bazlamit informs Montero that because of domestic shortages, Viewmont will need to import aluminum from Brazil for its U.S. plant. Payment for the aluminum will be in Brazilian reals (BRL) and is due on delivery three months from now. Bazlamit states, “To manage our translation exposure from unfavorable exchange rate movements, we should enter into a long forward contract on Brazilian reals.” Kemigisa has determined that in 60 days, Viewmont will also need to raise USD50,000,000 for domestic operations. To protect against a rise in interest rates over this period, Kemigisa is evaluating the purchase of a USD50,000,000 interest rate call option. Interest and principal on the loan is due upon its maturity. Details of the loan and the interest rate call are provided in Exhibit 1. Exhibit 1 Loan, Option, and Interest Rate Information Item Description Maturity of loan 180 days from today Loan amount USD50,000,000 Annual loan interest rate LIBOR + 0.50% Call option premium USD150,000 Call option strike 1% Call option expiration 60 days from today Call option underlying 180 day LIBOR Current LIBOR rate 1.5% Bazlamit suggests using an interest rate swap instead of interest rate call options. She states, “By entering into an interest rate swap in which we receive a floating rate in return for paying a fixed rate of interest, we can hedge against rising interest rates and thus stabilize Viewmont’s cash outflows. The swap will also reduce the sensitivity of Viewmont’s overall position to changes in interest rates.” Montero responds, “I think a better alternative to the interest rate swap you suggest is an interest rate swaption. For example, we could purchase a payer swaption with an exercise rate of 3% that allows us to receive a rate of LIBOR. If fixed rates rise above 3% in 60 days, then excluding the effect of the swaption premium, our net interest payment will be equal to 3%.” Viewmont is planning an expansion of its manufacturing capacity in Brazil. At the current exchange rate, BRL1.72/USD1, the expansion will cost BRL86,000,000, or USD50,000,000. Montero and his team discuss alternative ways to raise the capital required so that Viewmont can achieve the lowest borrowing cost and hedge against exchange rate risk. Bazlamit suggests Viewmont can achieve the lowest borrowing cost and avoid currency risk by borrowing directly in Brazilian reals. Kemigisa disagrees and suggests that Viewmont, being based in the United States, receives the best terms by borrowing domestically and then converting the proceeds to Brazilian reals at current exchange rates. Montero states, “Viewmont will enjoy the lowest borrowing cost by borrowing in U.S. dollars and then engaging in a currency swap to obtain Brazilian reals.” Earnings from the Brazilian operation are repatriated to the United States each quarter. Montero and his team estimate that over the next year, quarterly cash flows from the Brazilian unit will be BRL5,000,000. Montero asks his team to evaluate the use of a currency swap to manage the currency risk of the earnings repatriation. The swap will involve fixed interest for fixed payments and the annual fixed interest rate for payments in Brazilian reals is 5% and 3% for U.S. dollars.