Question

Moyes has taken delivery of 50,000 electronic devices from a firm in Malaysia. The seller is in a strong bargaining position and has priced the devices in Malaysian dollars at M$ 12 each.

It has granted Moyes 3 months’ credit. Malaysian interest rates are 3% per quarter. Moyes has all its money tied up in its operations but could borrow in sterling, its home currency at 4% per quarter if necessary.

Exchange rate :Malaysian dollar per £

Spot : 5.4165

Three-month forward= 5.425

A three-month sterling put, Malaysian dollar call currency option with a strike price of M$ 5.425/£ for M$ 600,000 is available for a premium of M$ 15,000.

Required:

a) Discuss, with the help of calculations three hedging strategies available to Moyes.

b) Weigh up the advantages and disadvantages of each strategy

Answer 1

Hedging strategies that available to Moyes

1. Forward contract - By entering forward contract @5.425/£ he can lock his cash outflows of M$ 3255000
2. By entering into money market hedge - As he has payables in M$ he has to invest equivalent money @3% per quarter : M$ 5,82,524.27 on maturity amount receivable will be 6Lakhs and the same can be used for payment. Above amount will be bought from £ spot which equals to £ 1,07,546.25 and the same can be bought at borrowing rate of 4% per quarter - cash flows after one quarter will be £ 1,11,848.10 ... hence he can fix cash flows now itself with no position open for exhange fluctuation.
3. 3rd option he has is Option contract which also fixes the cash outflows payable by him in future by paying premium.

Any one of above strategies can be used based on cash outflow