Question

Assume that a U.S. firm expects to make a payment of SF2,000,000 in 3 months and wants to execute a money market hedge. The following information is available:

U.S. borrowing interest rate = 7%; U.S. lending interest rate = 4%;

Swiss borrowing interest rate = 9%; Swiss lending interest rate = 7%;

Spot rate is $0.95/SF; The U.S. firm's weighted average cost of capital (WACC) is 9%.

Explain very well if the U.S. firm intends to use the money market hedge to cover the payment of SF2,000,000, what shall it do and what will be the total cost in USD in 3 months? (10 points)

Answer 1

A/C payable (AP) = SF2,000,000

Present Value (PV) of AP = AP/(1+ lending rate/4) = 2,000,000/(1+7%/4) = SF1,965,601.97

(Invest this amount now so that after 3 months, one can get SF2,000,000.)

Amount in USD = PV amount*spot rate = 1,965,601.97*0.95 = USD 1,867,321.87

For 3 months, the company will have to carry forward 1,867,321.87 so USD cost after 3 months is

USD amount*(1+company WACC/4)

=  1,858,190.71*(1+9%/4) = USD 1,909,336.61 (total cost in USD)