An exporter is a UK based company. Invoice amount is $350,000. The credit period is 3 months. Exchange rates in London are:
Spot rate $/£ 1.5865-1.5905
3-month foreward rate $/£ 1.6100-1.6140
Rates of interest in the money market are as below
Currency | Deposit | Loan |
$ | 7% | 9% |
£ | 5% | 8% |
Required
Show how the exporter can hedge the receivable using a forward contract and a money market contract. Compare the outcomes of the two
Base currency in this question is £
If hedged using forward contract:
Amount Exporter will receive after 3 months= $ invoice amount / ask rate= $350,000 / 1.6140 = £ 216,852.54
If hedged using money market contract,
Implied forward rate = ask rate x (1+borrowing in US) / (1+investing rate in UK)
= 1.5905 x (1+9%x3/12) / (1+5%x3/12) = 1.6062
Amount Exporter will receive after 3 months= $ invoice amount / ask rate= $350,000 / 1.6062 = £ 217,904.44
It is better to hedge using money market instruements
Get Answers For Free
Most questions answered within 1 hours.