Question

TIme remaining 1 hour

5. Armani, a European company, would like to hedge its $100 million receivable from the Gap, which it will receive in one year. It faces the following exchange and interest rates. Spot rate: $1.00/€ Forward rate (1 year): $1.02/€ Euro 1-year interest rate: 4% U.S. dollar 1-year interest rate: 5% Which hedging alternative would you recommend, money market hedge or forward?

Answer 1

Money Market Hedge :
Exposure =( million)	$                 100.00
will receive with in a year
Creat a liability and settle the liability using receivable
Hence borrow $ =	100/1.05
	95.23809524
Borrowing rate in US	5.00%
Covert the USD to EUR using spot rate
Spot rate =   USD 1 / EUR	1
Amount in EUR	95.23809524/1
	95.23809524
Invest EUR for one year :
EUR Rate per annum	4%
Amount received after one year =	95.23809524*1.04
	EUR 99.0476190 million

FORWARD HEDGE :

Amount will be received = $100 million /1.02

= EUR 98.0392157 million

Decision ;

MONEY MARKET HEDGING is appropriate because its exposure is more than forwad hedging