Question

the 90-day U.S. interest rate is 4.13%. The 90-day Malaysian interest rate is 4.75%. The 90-day forward rate of Malaysian ringgit is $0.402, and the spot rate of Malaysian ringgit is $0.402. Assume that the Santa Barbara Co. in the United States will need 234,535 ringgits in 90 days. It wishes to hedge this payables position. How much is the cost difference of Santa Barbara from implementing a forward hedge and a money market hedge (Please round to a dollar and use the absolute value)?

Answer 1

Basic Understanding: we will calulate present amount of dollars in both ways, whichever will be lower would be opted.

Forward option Method:

Step:1. Convert the payable amount after 90 days using forward contract = Payables * Forward rate

= 2,34,535 ringgit * $0.402/ringgit

= $94,283.07

Step:2. Present value of amount of dollars using U.S. Interest Rate= $94283.07/(1+4.13%)

= $90543.62

Money market option:

Step:1. An amount in ringgit will be invested in malasian risk free bonds for 90days to gets 2,34,535 ringgit.

Step:2. In order to get ringgit amount, X dollars will be converted in Ringgit using spot rate, i.e. (x/.402)

Step:3. As a result, resultant amount will be (x/.402)*(1+4.75%).

Step:4. Also, we can say,  (x/.402)*(1+4.75%)=234535

x=$90,007