Question

1. A U.S. firm has a MXN 40,000,000 payable (money they will owe to a supplier, for example) due in 7 months. The current exchange rate is $.10/MXN and the U.S. firm fears the MXN could appreciate substantially over the next 7 months. The interest rate on 7-month MXN money market deposits is 4.00% (a periodic rate, not a yearly rate). How could the U.S. firm execute a money market hedge? (Show everything and include numbers)

Answer 1

ANSWER

Amount payable after 7 months by U.S. firm = MXN 40,000,000

Interest rate on 7 month MXN money market deposits = 4.00%(7 months rate)

Step1:

US firm would invest in MXN or foreign currency:

Amount payable(in MXN)/ (1 + .04)

= 40,000,000/ 1.04

= MXN 38,461,538(Approximately)

Step 2:

Spot rate ($/MXN) = $.10

Borrow equivalent amount of $ in home currency using spot rate

= 38,461,538 * Spot exchange rate

= 38,461,538 * .10

= $3,846,154

U.S. firm should borrow $3,846,154 to get MXN 38,461,538 for investing.

This invested amount of  MXN 38,461,538 by US firm will give MXN 40,000,000 which can be used to pay amount payable.

Therefore, payment of borrowing after 7 months would be,

$3,846,154 + $3,846,154 *  interest rate on 7-month $ money market loan