Uise the following information for questions 8 - 15 f360-$1.55/E lf i,-8%, i6% S

Question

Uise the following information for questions 8 - 15 f360-$1.55/E lf i,-8%, i6% S-$1.52/E, and 8) If you use the Money Market to hedge a £100,000 A/P exposure, what are steps? How much you need to invest? And Where? How much you need to borrow? And Where? 9) What is the cost of the Money Market Hedge? 10)If you use the forward market to hedge, will you BUY or SELL the Pounds forward? 11) What is the cost of the Forward Hedge? 12) Would you prefer to hedge the A/P in the forward market or the money market? Why? Hedging Account Reccivables 13) Rather than hedging a £100,000 A/P, assume that you want no Money Market to hedge a £100,000 A/R exposure, what are st How much you need to borrow? And Where? How much you need to invest? And Where? 14)If you use the forward market to hedge, will you BUY or SELL the Pounds forward? 15) Would you prefer to hedge the A/R in the forward market or the money market? Why? End of the Exam

Explanation / Answer

Part - 8

A. Amount Deposit

1.Future Value of Currency payable ( Given ) = 100,000 Pound

2.Deposit Present Value of Exposure using Pound Interest

rate whose realisation can be used to settle payable = 94,339.62 Pound (100,000/1.06)

B. Amount Borrowed

Borrow Locally and convert $ to Pound to make Foreign currency

Deposit = 143,396.22 $ (94339.62 Pound *1.52$)

PART - 9

Cost of Money Morket Hedge

Money Market Hedge = 143396.22 $ * 1.08

= 154867.92$

PART -10

FORWARD HEDGEING DECISION

1. Identification of currency

Local Currency : $

Foreign currency : Pound

2. Forward premium/ discount

FR - SR/SR*12/n*100

=1.55-1.52/1.52*12/12*100

Premium = 1.97%

C. Application Rule

Local Interest Rate = 8%

Foreign Interest Rate =6%

Adjusted Foreign interest Rate = 6% + 1.97%

=7.97%

Since 8% is More than 7.97% ,borrow Foreign currency and Invest Local currency

PART -11

Cost of forward hedge

100000 Pound * 1.55$

=155000$

PART -12

Decision whether Money market hedge or Forward Hedge

Money Market = 154,867.91$

Forward Hedge = 155,000 $

Money Market is Selected because outflow is less than Forward hedge

Hedging Accounts Receivable

PART -13

Borrow

100000 Pound * 1/1.06 = 94339.62 pound

Invest

94339.62 *1.52$ =143396.22 $

Part - 14

Forward Hedge Rate = 7.97% Interest (Previous Computation)

Forward Rate = 8%

Decision is Selling the Pound

PART - 15

Money Market Hedge =154,867.92$

Forward Hedge =155000 $

Decision : Forward Hedge is selected because Receivable is more than Money Market Hedge

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