Homework 3
04/25/18
1. Assume the following information:
90‑day U.S. interest rate = 4%
90‑day Malaysian interest rate = 3%
90‑day forward rate of Malaysian ringgit = $.400
Spot rate of Malaysian ringgit = $.404
Assume that the Santa Barbara Co. in the United States will need 500,000 ringgit in 90 days. It wishes to hedge this payables position. Would it be better off using a forward hedge or a money market hedge? Substantiate your answer with estimated costs for each type of hedge.
1) Hedging through forward hedge
Company will get 500,000 ringgit after 90 days for,
= 500,000 x $ 0.400
= $ 200,000.00
2) Hedging through Money market hedge
Borrow necessary USD @ 4% p.a. and buy Malaysian ringgit today @ spot rate of $ 0.404 and invest it in Malaysian market @ 3% p.a. for 90 days and pay off the liabilities arose after 90 days using realized amount
We need to find amount need to invest today in Malaysia to get 500,000 ringgit after 90 days
Present value of 500,000 ringgit when i=0.75% (i.e. 3% x 90/360), n=1
PV factor for $ 1 will be = 1 / (1 + 0.0075)^1
= 0.992555831265509
require investment amount of ringgit today will be = 500,000 x 0.99255831265509
=$ 496279.156327545
USD required for buy 496279.156327545 ringgit today
= 496279.156327545 x 0.404 =$ 200496.779156328
Borrow $ 200496.779156328 @ 4% for 90 days
Interest amount will be
=200496.779156328 x 4% x 90/360 = $ 2,004.96779156328
Total USD cost if hedging done through money market
=$ 200496.779156328 + $ 2,004.96779156328=$ 202,501.746947891
Hedging using forward contract is best option and company should opt for forward exchange
2. SMU Corp. has future receivables of 1,000,000 New Zealand dollars (NZ$) in one year. It must decide whether to use options or a money market hedge to hedge this position. Use any of the following information to make the decision. Verify your answer by determining the estimate (or probability distribution) of dollar revenue to be received in one year for each type of hedge.
Spot rate of NZ$ = $.54
One‑year call option: Exercise price = $.50; premium = $.07
One‑year put option: Exercise price = $.52; premium = $.03
U.S. New Zealand
One‑year deposit rate 9% 6%
One‑year borrowing rate 11 8
Rate Probability
Forecasted spot rate of NZ$ $.50 20%
.51 50
.53 30
Put Option hedge (Excercise price = $ .52 : premium = $ 0.03)
Possible Spot
Put Option Premium
Exercise Option
Amount per unit Received (also accounting for premium)
Total Amount Received for NZ $ 2000,000
Probability
$ .50
$ .03
Yes
$ .49
980000
20%
$ .51
$ .03
Yes
$ .49
980000