Tiffany & Co exports new products to France and has receivables of Euro902,255.6

Question

Tiffany & Co exports new products to France and has receivables of Euro902,255.64 Assume that the one-year interest rates are 2% and 6% in the U.S. and France respectively. Further, while the spot rate and one-year forward rate for Euro are $1.33 and $1.3743. Find how much Tiffany & Co will receive in U.S. dollars one year from now if it uses a money market hedge.

Select one:

a. $1,143,169.81

b. $1,131,738.11

c. $1,257,486.79

d. $1,154,716.98

e. none of the answers is correct

Consolidated Edison Inc exports new products to Denmark and has receivables of Danish Krone9,868,421.05 Assume that the one-year interest rates are 2% and 6% in the U.S. and Denmark respectively. Further, while the spot rate and one-year forward rate for Danish Krone are $0.1216 and $0.1257. Find how much Consolidated Edison Inc will receive in U.S. dollars one year from now if it uses a money market hedge.

Select one:

a. $1,143,169.81

b. $1,257,486.79

c. none of the answers is correct

d. $1,131,738.11

e. $1,154,716.98

Explanation / Answer

TIFFANY & CO:

Euros receivable = 902,255.64

Money Market hedge :

1) Borrow from the Bank in Euros, such that the amount of Euros borrowed plus interest payable after 1 year (at 6%) becomes equal to Euros receivable. Let the amount borrowed be X,

=> X + X * 6% = 902,255.64

=> X = 902,255.64 / 1.06 = Euro 851,184.56

2) Convert the borrowed Euros into $ using the Spot Rate (Euro 1 = $ 1.33)

$ amount = Euro 851,184.56 x 1.33 = $ 1,132,075.46

3) Now, Invest this amount of US $ at 2% interest for 1 year.

4) At the end of 1 year :

Repay to the bank the Euros borrowed, after receiving it from the customer = Euro 902,255.64

Realise the Amount invested in US $ with interest = $ 1,132,075.46 x 1.02 = $ 1,154,716.97. This is closest to the value in Option D (difference is due to rounding off).

Hence answer is Option D.

CONSOLIDATED EDISON INC:

Danish Krone receivable = 9,868,421.05

Money Market Hedge : (follow the same operation as above)

1) Borrow in Danish Krone (DK) - let the amount borrowed be X, Denmark Interest rate = 6%

=> X + X * 6% = 9,868,421.05

=> X = 9,868,421.05 / 1.06 = DK 9,309,831.18

2) Convert the DK amount borrowed to US $ at the Spot Rate (DK 1 = $ 0.1216)

$ Amount = DK 9,309,831.18 x 0.1216 = $ 1,132,075.47

3) Now, Invest this amount of US $ at 2% interest for 1 year

4) At the end of 1 year :

Repay to the bank the Danish Krone borrowed, after receiving it from the customer = DK 9,868,421.05

Realise the Amount invested in US $ with interest = $ 1,132,075.47 x 1.02 = $ 1,154,716.98 (rounded off) - same as Option E.

Hence, the answer is Option E.

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