Your multinational corporation has net inflows (e.g. Accounts Receivable) of $1
ID: 2457346 • Letter: Y
Question
Your multinational corporation has net inflows (e.g. Accounts Receivable) of $1 million from Germany. In addition, your company financed the operations through a Swiss bank, such that you owe $1.1 million to pay off the loan in Switzerland (this Note and Interest Payable can be treated like an Account Payable). Both cash flows are due in six months.
We have learned that the Swiss franc and the Euro are highly correlated (r = .95). Assume that this high correlation is expected to continue. Your forecasting staff has indicated that the Swiss franc may exhibit minor appreciation over the next few months, but depreciation is unlikely.
You have determined that a forward hedge or a money market hedge would give the same result.
As top manager in your companys Currency Risk Management Division, what you will decide to do concerning these currency exposures, and (briefly) explain why?
Address these ideas: net exposure, amount to hedge, choice of hedge method (if any), cost of initiating hedge.
Explanation / Answer
We can sign forward contract. Sinc we expect an appreciation in Swiz frank it will leads more otflow of money. Total swiz frank payable is 1.1 million. If foreign currency appreciated the amount payable in term Home currency will be more. To avod the risk it is better to sign a forward contract. It will reduce the risk.
For foreign currency receivable the appreciation in it's value will provide more inflow in term of Home currency. Since Euro and Swiz frank are expected to move in same direction the appreciation of Euro will benefit the company. Since currency exchange rate are highly flactuating it is better to sign a forward contract for Euro receivables also.
Net Exposure:
It is the extent which our fund is exposed to market rate flactuations. Gross exposure represent the total fund percentage exposed to market risk. That is total of long position and short position. The net off short and long position is called net exposure. A low net position doesnot neccessarly means that risk is very low.
Amount to hedge:
We have to sign to forward hedge. One is forward selling contract for Euro ie equal to $ 1 million another for forward buying contract for Swiz franc for $ 1.1 million
Choice of hedge:
Forward contract
Money market hedge
Futtures
Cost of initiating hedge:
The margin money is the initial cost of hedge. Margin money deposit for ensure the performance of hedge.
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