Your multinational corporation has net inflows (e.g. Accounts Receivable) of $1

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 company’s 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

Given this current situation since the co's accounts payable is higher than the receivable , and since the due date is same for both financials ie 6 months. To meet the obligation to pay for the payables, the co. should go to hedge the principal amount.

The net exposure is Payable - Receivable= 1.1 - 1 million = .1 million.

The best method to have it would be to go for prinicpal Hedge, ie we should hedge the entire amount of 1.1 million. So PV of the hedge of the principal of 1.1 million should be amount hedged. This would grow into 1.1 m in 6 months, which would help the co to pay off the payables.

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