Question

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:

U.S.
Singapore

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?

A.

$310,115

B.

$325,450

C.

$311,428

D.

$305,000

Answer #1

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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