Question

Use the following information to calculate the dollar cost of using a money market hedge to hedge 200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $2.02, the 180-day forward rate is $2.00. The British interest rate is 6%, and the U.S. interest rate is 4% over the 180-day period. $351,210. $381,210. $371,210. $400,152

Answer 1

Under money market hedge, the currency which is to be paid in future is obtained at spot rate and invested such that the amount on maturity becomes equal to the amount payable

Amount payable = Pounds 200,000

Funds required today = 200,000/(1+0.06*180/360) = Pounds194,174.76

Cost of Dollar = 194,174.76*2.02 = $392,233

Hence, the amount of dollar borrowed today = $392,233

Payment of loan after 180 days = 392,233*(1+0.04*180/360)

= $400,077.67

i.e. the answer is $400,152

The minor difference is due to rounding off

The number of days taken in a year = 360