Bradley Machine Corp. expects to need S$500,000
(Singapore dollars) for an accounts payable in one year. The
current spot rate of the Singapore dollar is $0.60/S$. The one
year forward rate of the Singapore dollar is $0.62/S$. The spot
rate in one year is forecasted to be $0.61/S$. The firm’s WACC
is 12% per year.
Assume that one year put options on Singapore dollars are available, with an exercise price of $0.63/S$ and a premium of $0.04/S$. One year call options on Singapore dollars are available with an exercise price of $0.60/S$ and a premium of $0.03/S$. Assume the following money market rates:
Deposit rate 8% 5%
Borrowing rate 9% 6%
Assume that for money market hedges, the firm invests or borrows at the short-term deposit rates given above rather than at their WACC. Given this information, what would be the total cost in USD to Bradley of the S$500,000 if the Money Market Hedge is chosen?
|BMC has a S$ liability of 500,000. So it has to set up a|
|an asset which will have a maturity value of|
|S$500,000 in one year.|
|So, it has to deposit S$500000/1.05 =||476190||S$|
|For the required S$476,190, borrowing will be made in $. The borrowing required 476190*0.6 =||$ 2,85,714|
|The amount repayable under the loan will be 285714*1.09 =||$ 3,11,428|
The above amount will be the net outflow in dollars
against the payable.
|Answer: [C] $311,428|
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