Assume the following information: 90-day U.S. interest rate 4% 90-day Malaysian

Question

Assume the following information:

90-day U.S. interest rate                               4%

90-day Malaysian interest rate                       3%

90-day forward rate of Malaysian ringgit       $.400

Spot rate of Malaysian ringgit                        $.404

Assume that the Santa Barbara Co. in the United States will need 300,000 ringgit in 90 days. It wishes to hedge this payables position. Would it be better-off using a forward hedge or a money market hedge? Substantiate your answer with estimated costs for each type of hedge.

Explanation / Answer

If the Santa Barbara co use the money market hedge ,it will invest (3000000
.03)=291262Ringgit

Now in Malaysian deposit that will accumulate to 3000000 ringgit in 90days.

This implies that the number of U.S dollars to be borrowed now is 291262*$.404=$117670

If this amount is borrowed today ,santa Barbara will need $122377 to repay the loan in 90 days.

$117670*1.04=$122377

In comparison ,the santa Barbara co will pay out $120000 in 90 days if it uses the forward hedge.

$122377 in the case of money market hedge

Thats the reason Forward hedge is better here.

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