Question

Use for Math 1 and 2:

Spot Rate                                                                    1.050 – 51 Sf/E

Forward (6 month)                                                     1.060-61 Sf/E

Swiss Rates (annualized)       Invest / Borrow           8% / 10%

Euro Rates (annualized)         Invest / Borrow           4% / 6.00%

1. Renault is a European importer who wants to hedge 300,000 sf exposure. Hedge it using the forward rate hedge, and the money market hedge.

2. If I was interested in buying either Swiss or Euro Tbills for an investment, Which should I choose. (hint: think covered interest arbitrage. There are 4 answers)

Answer 1

1. The SF 300,000 exposure can be hedged using Forward hedge. The price so fixed will be 6 month forward rate of SF 1.060/Euro

The total amunt of Euro payable after 6 months= SF 300000 / (SF1.060/ Euro) = Euro 283,018.87

Using money market hedge, Amount in Euro can be borrowed for 6 months today and converted to SF. The amount is then invested in SF for 6 months in such a way that final maturity amount is SF 300000

So, amount to be invested in SF today = 300000/(1+0.08/2) = SF 288461.54

The equivalent amount in Euro to be borrowed today = 288461.54/1.05 = Euro 274725.27

Maturity amount of Euro loan = 274725.27* (1+0.06/2) = $282967.03

2. From above, it can be said that investing money in SF is better as per the current and forward exchange rates

So, buying the Swiss Treasury Bills is a better option as compared to Euro T bills. By investing in SF treasury bills, one can make more money.