SUPPOSE YOU HAVE A PAYABLE IN THE AMOUNT OF CHF 34,000 SWISS FRACS THAT HAS TO B
ID: 2710165 • Letter: S
Question
SUPPOSE YOU HAVE A PAYABLE IN THE AMOUNT OF CHF 34,000 SWISS FRACS THAT HAS TO BE MET IN 30 DAYS. THE ANNUAL INTEREST RATE IN SWITZERLAND IS 1.06%, AND THE ANNUAL INTEREST RATE IN THE us IS 2.45% THE SPOT EXCHANGE RATE IS $1.0168. IF THE 30-DAY FORWARD EXCHANGE RATE IS $1.0597, SHOULD THE FIRM USE A FORWARD HEDGE OR A MONEY MARKET HEDGE? YOU SHOULD CHOOSE YOUR ANSWER ONLY AFTER CALCULATING THE COST IN DOLLARS OF MEETING THE PAYABLE BY A FORWARD HEDGE AND BY A MONEY MARKET HEDGE. DO ALL INTEREST RATE CALCULATIONS TO AT LEAST 5 DECIMAL PLACES.
Explanation / Answer
Amount Payable using
Forward Market Hedge = $ 36,029.80
Money Market Hedge = $ 34,611.21
Since money market hedge results in a lower pay-off, the same is preferable
Amount payable in 30 days = CHF 34000
Spot Exchange rate = $1.0168 / CHF
Forward Exchange rate = $1.0597/ CHF
Forward Market Hedge
Amount Payable in USD using Forward Market Hedge = CHF 34000 * 1.0597 = $ 36,029.80
Money Market Hedge
Amount Payable after 30 days = CHF 34,000
The steps involved are
Borrow USD amount equivalent to todays value of CHF at 2.45% for 30 days.
Deposit the CHF amount for 30 days at 1.06% to receive CHF 34000 to clear off payable.
Annual Interest rate in Switzerland = 1.06% monthly interest rate = 1.06%/12 = 0.088333%
Amount to be deposited now to get a maturity value of CHF 34000 = 34000/1+0.088333%
= 34000 / 1+0.00083333 = 34000 * 0.999117446 = 33969.99 (rounded off)
That is if we deposit CHF 33969.99 at 1.06% for 30 days if receive an amount of CHF 34000 to clear off the payable in 30 days
Value of CHF 33969.99 at spot rate today = CHF 33969.99 * $ 1.0168
= $ 34,540.6858 or $ 34,540.69 (rounded off)
Borrow $ 34,540.69 at 2.45% per annum for 30 days (monthly interest rate 0.2041666%)
Maturity value of the loan = $ 34,540.69 * (1+0.20416667%)
= $ 34,540.69 * (1.0020416667) = $ 34,611.21
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