Your firm is an Italian exporter of bicycles. You have sold an order to a Swiss

Question

Your firm is an Italian exporter of bicycles. You have sold an order to a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment from the customer (in Swiss francs) is due in 12 months. Use a money market hedge to redenominate this one-year franc denominated receivable into a euro-denominated receivable with a one-year maturity.

Contract Size Country U.S. $equiv.Currency per U.S. $ Britain (pound) 12 months forward Euro 12 months forward Swiss franc 12 months forward $1.9600 $2.0000 $1.5600 $1.6000 $0.920e $1.000e £10,006 interest APR £0.5102 £8, 5088 0.641e 0.6250 rates 10,006e te 2% í£ = 3% SFr.10,000 SFr.1.0000

Explanation / Answer

For creating a MM Hedge, a SFr liability is to be created so that its maturity value at the end of year 1 will be SFr2000000. For this the following steps would be required today: 1) Amount to be borrowed today in SFr = 2000000/1.04 = 1923076.92 SFr 2) Convert into SFr at spot rate to get Euros, through the dollar route = 1923076.92*0.92*0.6410 = €       11,34,076.92 3) Invest Euros 1134076.92 at 2% to get 1134076.92*1.02 = €       11,56,758.46 after 1 year. At the EOY 1, the following action would be taken. 1) Receive the amount of SFr2000000, and pay the loan in SFr which would then have an equivalent maturity value. 2) Receive the maturity value of the Euro deposit of 1156758.46. This is the euro-denominated receivable with a one-year maturity.

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