Question

Use the following information to calculate the dollar cost of using a money market hedge to hedge 300,000 pounds of payables due in 90 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $2.05, the 90-day forward rate is $2.00. The British interest rate is 5%, and the U.S. interest rate is 4% over the 90-day period. Please, show all your calculations step by step how you reach your solution, a single numeric answer will not be given any credits.

Answer 1

We need to follow below steps to calculate the dollar cost of using the Money market hedge.

Step 1 : Invest the Present value of 300,000 Pounds @ 5% for 90 days ie 1.25% for 90 days after assuming 360 days in a year

Amount to be invested today in Pounds = 300000 / 1.0125 = 296,296.30 Pounds

Step 2 : Buy the present value of the amount to be invested in Pounds at the spot rate of $2.05

The amount of dollars required to buy 296,296.30 pounds = 296296.30 * 2.05 = $607,407.41

Step 3 : Borrow Dollars 607, 407.41 in for 90 days @ 4% ie 1% for 90 days.

Outflow after 90 days = 607,407.41 * 1.01

= $613,481.49