Question

U.S. borrowing rate for 1 year                        = 5%

U.S. deposit rate for 1 year                             = 2%

Lebanese Pound borrowing rate for 1 year     = 9%

Lebanese Pound deposit rate for 1 year          = 6%

Spot quote                                                      = 1509 ‑ 10 USDLBP

Lebanese Pound 1‑year forward quote           = 1567 - 68 USDLBP

3. Using the same data listed above, as a Lebanese importer, please use the forward and money market hedge to protect a 100,000 $ payable.(10)

Answer 1

Using Forward Rate to protect the rise in dollar rate vis a vis Labanese Pound . The importer is worried of rise in Dollar rate. So he will protect himself from the rise in excahnge rate by locking in a forward rate of 1$=1567.68 LBP.

So Outflow after 1 year = 1567.68*100000 = 156768000 LBP payable after 1 year.

Using Money Market Cover -

Step 1:- Pay $100000 today. So amount of foriegn exchange payable is = 100000/1.02= $98039.22

Step 2:- Buy $98039.22 Today @1509.10 (Spot Rate)=147950,980.40 LBP.

Step 3 Borrow Above LBP @9%. So Outflow after 1 year 161266568.63 LBP

We see that outflow under forward cover is the least and should be preferred.