Question

You are US company, 300,000 BP (British Pound) payable to UK in one year. Answer in terms of US$.

Information for Forward Contract:

Forward exchange rate (one yr): 1.52 $/BP

Information for Money Market Instruments (MMI):

Current exchange rate: 1.48 $/BP

Investment return at Aerion Fund Management (in UK): 8% annual

Interest rate of borrowing from Bank of America (in USA): 3% annual

Information you need for Currency Options Contract:

Options premium: 0.015 $/BP

Interest rate of borrowing from Bank of America (USA): 2% annual

Allowed to exercise options at 1.54 $/BP

What are the costs of MMI? (Answer in US$ of course. You are US company!)

Group of answer choices

about $335,577

about $423,444

about $462,421

about $340,082

Answer 1

As we have amount payable in UK ,to hedge we need to invest on an asset that will return 300000 BP in a year.

So investment to be made in UK will be = 3000000/1.08 = 277777.78 BP (8% interest received)

So amount equivalent to 277777.78 BP should be borrowed at the beginning of the year from USA @ 3% interest.

Amount to be borrowed in US $ =277777.78 * 1.48 = 411111.12 US$

Amount to be repaid after 1 year = 411111.12 * 1.03 = 423444.46 US$

Thus, the costs of MMI is Option b) about $423,444 US$.