Your multinational corporation has net inflows (e.g. Accounts Receivable) of $1
ID: 2720244 • 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 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
In a Forward hedge stategy we need to buy the currency at a pre-determined rate (i.e Forward rate) .
This may not relieve the company from entire currency risk.
Money market hedge is better as we can find out the amount of outflows or inflows in home currency now .
In this strategy we need to take loan of the present value of inflows from germany and convert the amount into home currency at current Exchange rate between germany and swiss.At the end the amount received is paid to bank
Net Exposure is the amount of currency at risk
Amount of hedge is the amount which needs protection from any risk of losing money
Cost of Initiating hedge is minimum amount to be paid to initiate the hedging strategy . for example premium paid for call option
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