An exporter is a UK based company. Invoice amount is $3,50,000. Credit period is three months. Exchange rates in London are :
Spot Rate ($/£) 1.5865 – 1.5905
3-month Forward Rate ($/£) 1.6100 – 1.6140
Rates of interest in Money Market :
Deposit Loan
$ 7% 9%
£ 5% 8%
Compute and show how a money market hedge can be put in place.
Compare and contrast the outcome with a forward contract.
Solution
An Uk firm can hedge its exposure by Money Market Operations UK Firm – $ 3,50,000 receivable after 3 months
MMC ( Borrow – sell – invest )
Step 1 : Borrow $ so that amt payable is $ 3,50,000 after 3 months @9%
P.A i.e 2.25% per quarter
Amount to be borrowed: 3,50,000 / 1.0225 = $ 3,42,298.29
Step 2 : Convert: Sell $ and buy £. The relevant rate is the Ask rate, namely, 1.5905 per £, (Note: This is an indirect quote).
Amount of £s received on conversion is 2,15,214.27 (3,42,298.29 / 1.5905).
Step 3 : Invest: £ 2,15,214.27 will be invested at 5% for 3 months Amount receivable after 3 months £ 2,17,904.45
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