Question

SRI Co. is a Sri Lankan MNC. SRI Co. expects to receive $750,000 in a year from a U.S. customer. Current spot rate is Rs. 177.0 per $. SRI Co. can borrow funds in the U.S. at 5 percent and invest funds in the U.S. at 4.5 percent. SRI Co. can borrow funds in Sri Lanka at 8 percent and invest funds in Sri Lanka at 6.5 percent. SRI Co. would like to hedge all the exchange rate risk from the receivables. What is the approximate value of the receivables if SRI Co. use a money market hedge?

	A.	Rs. 143 million.
	B.	Rs. 139 million.
	C.	Rs. 137 million.
	D.	Rs. 135 million.
	E.	Rs. 131 million.

Answer 1

In a money market hedge, to hedge the USD receivables, SRI Co, has to borrow the USD amount today such that the amount to be repaid after one year exactly matches the Receivables. This USD amount has to be converted to  Rupee and invested in Sri Lanka.

Amount to be borrowed in USD today = $750000/ 1.05 = $714285.71

$714285.71 converted to Rs. becomes = $714285.71 * Rs.177/$ = Rs.126428571.43 which is invested for one year in Sri Lanka at 6.5%

So the final receivables after one year in Rs. = Rs.126428571.43 * 1.065 = Rs.134,646,428.57 or apx Rs.135 million (Option D is the correct answer)