Money Market Hedge on Receivables
1. Money Market Hedge on Receivables. Assume that Stevens Point Co. has net receivables of 100,000 Singapore dollars in 90 days. The spot rate of the S$ is $.50, and the Singapore interest rate is 2% over 90 days. Suggest how the U.S. firm could implement a money market hedge. Be precise. ANSWER: The firm could borrow the amount of Singapore dollars so that the 100,000 Singapore dollars to be received could be used to pay off the loan. This amounts to (100,000/1.02) = about S$98,039, which could be converted to about $49,020 and invested. The borrowing of Singapore dollars has offset the transaction exposure due to the future receivables in Singapore dollars. 2. Money Market Hedge on Payables. Assume that Hampshire Co. has net payables of 200,000 Mexican pesos in 180 days. The Mexican interest rate is 7% over 180 days, and the spot rate of the Mexican peso is $.10. Suggest how the U.S. firm could implement a money market hedge. Be precise. ANSWER: If the firm deposited MXP186,916 (computed as MXP200,000/1.07) into a Mexican bank earning 7% over 6 months, the deposit would be worth 200,000 pesos at the end of the sixmonth period. This amount would then be used to take care of the net payables. To make the initial deposit of 186,916 pesos, the firm would need about $18,692 (computed as 186,916 × $.10). It could borrow these funds. 3. Hedging with Forward Contracts. Explain how a U.S. corporation could hedge net receivables in Malaysian ringgit with a forward contract. Explain how a U.S. corporation could hedge payables in Canadian dollars with a forward contract. ANSWER: The U.S. corporation could sell ringgit forward using a forward contract. This is accomplished by negotiating with a bank to provide the bank ringgit in exchange for dollars at a specified exchange rate (the forward rate) for a specified future date. The U.S. corporation could purchase Canadian dollars forward using a forward contract. This is accomplished by negotiating with a bank to provide the bank U.S. dollars in exchange for Canadian dollars at a specified exchange rate (the forward rate) for a specified future date. 4. Benefits of Hedging. If hedging is expected to be more costly than not hedging, why would a firm even consider hedging? ANSWER: Firms often prefer knowing what their future cash flows will be as opposed to the uncertainty involved with an open position in a foreign currency. Thus, they may be willing to hedge even if they expect that the real cost of hedging will be positive 5. Hedging Payables. Assume the following information: 90day U.S. interest rate = 4% 90day Malaysian interest rate = 3% 90day forward rate of Malaysian ringgit = $.400 Spot rate of Malaysian ringgit = $.404 Assume that the Santa Barbara Co. in the United States will need 300,000 Read More …