Question

German based company trading in Euros (€) wants to use money market hedging to reduce currency risk for anticipated future cashflows in Australian Dollars (A$).

The cashflows are as follows:

• A receipt of A$2m after 2 months
• A payment of A$3.5m after 4 months

The current spot rates are A$1.7512 - 1.7578/€.

Q: If inflation in Australia(foreign) was 4% per annum and 7% in Germany(domestic) use the Fischer equation to calculate what the spot rates would have been on the transaction date?

Answer 1

As per Fischer

Expected spot rate = Current spot rate * (1+inflation rate in Australia* no. of months/12)/(1+inflation rate in Germany*no. of months/12)

For receivables in Australian Dollar, we will use the Ask rate of the quote

So, Expected spot rate after 2 months

= 1.7578* (1+0.04*2/12)/(1+0.07*2/12)

=1.7491

So, spot rate after 2 months will be A$ 1.7491/Euro

Similarly, Expected spot rate after 4 months

= 1.7578* (1+0.04*4/12)/(1+0.07*4/12)

=1.7406

So, spot rate after 4 months will be A$ 1.7406/Euro