Question

Eastman Chemical an American importer from France is trying to hedge a payable denominated in Euro using a money market hedge, given the following information:

U.S. interest rate for 1 year                 = 6%

European interest rate for 1 year       = 4%

Euro spot quote                                   = $1.08

Euro 1‑year forward quote                  = $1.15

What will EMN do to hedge the payable of € 5 million due in one year, if it executes a money market hedge today?

	Deposit in US $ 5,192,307.7 at 4% per year
	Borrow in US $4,807,692.3 at 6% per year
	Borrow in France € 4,807,692.3 at 4% per year
	Borrow in US $ 5,192,307.7 at 6% per year
	Deposit in France € 4,807,692.3 at 4% per year

Can you explain why you deposit at 6% other than borrow at 4%  

Answer 1

Exposure is Euro 5 million payables due in one year

Here he is liable to pay 5 million in one year

Therfore invest present value of 5 million today at EURO INTEREST rate and settle the PAYABLES with maturity value of INVESTMENT . DEPOSIT AMOUNT will beome 5 million in one year.

Deposit amount 5 million/1.04 = EUR 4807692..31 (@ 4%)

CONVERT these to USD by using spot rate = EUR 4807692.31* 1.08 = $ 5192307.69

Then BORROW in US $ 5192307.69 AT US INTEREST RATE 6%