Question

ABC exports to France. The company expects to receive EUR100,000 in one year from its sales. Since it does not want to speculate in the foreign exchange market, ABC decides to hedge in the Money Market. How would it go about implementing its hedge?

Assume that the current exchange rate is USD1.2=EUR1;

the U.S. interest rate is 3%, and the French interest rate is 5%.

Explain your answer.

Answer 1

A money market hedge is done with these steps :

• Borrow in EUR an amount equal to the present value of the EUR receivable (discounted at the France interest rate) for 1 year. Amount borrowed in EUR =  100,000 / (1 + 5%) = EUR 95,238.10
• Convert the EUR borrowed into USD at the spot exchange rate. USD received today = 95,238.10 * 1.2 = USD 114,285.71
• Invest the USD received at the US interest rate for 1 year. USD received after 1 year = 114,285.71 * (1 + 3%) = USD 117,714.29
• After 1 year, the acutal receipt of EUR 100,000 is used to repay the EUR borrowed.