Given this, and that they have received a boost in profit on this project based on favorable interest rate fluctuation over the bid period, it would be best to enter into a hedge in order to lock in some of these profits.
A forward contract would lock in a profit of $165,643 on the project. The risk would be fully hedged at this point.
A foreign currency loan replaces fully hedges the risk as well. The cost is the interest paid of $81,562.50 and the fee paid of $3,262.50. The profit would be based on today's spot rate, less the combined fees of $84,825. Thus, the total profit of this option would be $173,406.
Buying a put would cost $58,725 and lock in a worst-case rate of 1.3888, which yields a profit of $133,296.20. The upside is technically the full value of the contract should the Canadian dollar strengthen infinitely. Writing a call would generate $92,916 for a maximum profit of $226,212.20. There would be downside risk, however, that could significantly erode this profit. Because writing a call does not hedge the downside risk, it is not a viable option for TCAS.
A foreign currency future contract would...
This yields a profit of $163,676, not including the remaining $10,000 that would be unhedged since each futures contract comes in an increment of $100,000.
The pre-sale of a foreign contract has a cost for the 90-day period of $60,030 plus a transaction fee of $13,050 for a total cost of $73,080. This is based on today's spot, giving a profit of $100,860.
A tunnel forward has no upfront cost and gives a partial hedge. The best case scenario is a profit of $220,092.50 and the worst case is a profit of $115,735.00.
I would recommend that TCAS take out a foreign currency loan. They have a tough competitive environment and an eroded customer base. The outlook for the Canadian dollar is not favorable for TCAS. In addition, each option with a fixed downside gives TCAS a profit higher than was anticipated when the bid was first submitted of $97,968.20. To take any of the fixed-downside options would be to lock in some of the gains already won.
Given this, the best option is to lock in as much of the profit that have already been won, rather than seek more. The option…
