Question

FOREIGN EXCHANGE

QUESTION ONE

The Dutch manufacturer Cloghopper has the following JPY commitments:

        i.            A/R of JPY 1,000,000 for thirty days.

      ii.            A/R of JPY 500,000 for ninety days.

    iii.            Sales contract (twelve months) of JPY 30,000,000.

    iv.            A forward sales contract of JPY 500,000 for ninety days.

      v.            A deposit that at maturity, in three months, pays JPY 500,000.

    vi.            A loan for which Cloghopper will owe JPY 8,000,000 in six months.

  vii.            A/P of JPY 1,000,000 for thirty days.

viii.            A forward sales contract for JPY 10,000,000 for twelve months.

    ix.            A/P of JPY 3,000,000 for six months.

 

Required:

(a)    Compute Cloghopper’s net exposure for each maturity?  (10 marks)

(b)   Explain how would Cloghopper hedge the exposure for each maturity on the forward market?  (8 marks)

Assume that the interest rate is 5 percent (compound, per annum) for all maturities and that this rate will remain 5 percent with certainty for the next twelve months. Also, ignore bid-ask spreads in the money market. How would the company hedge its exposure on the spot market and the JPY money market? Describe all money-market transactions in detail. 


QUESTION TWO

XYZ Ltd, a UK firm has bought goods from a US supplier and must pay US$ 4 million in 3 months time.  The company finance director wishes to hedge against the foreign exchange risk and is considering 4 methods:

i)                    Using the forward exchange contract

ii)                  Using the money market hedge

iii)                Using currency option

iv)                Using a lead payment

 

Annual interest rate and foreign exchange rate are given below:

                                                                                                                                                                                                                                                US $                                                                UK £

Deposit Rate                      Borrowing Rate          Deposit Rate   Borrowing Rate

1 month             7%                             10.25%                        10.75%                        14.0%

3 months           7%                             10.75%                        11.4%                          14.25%

 

Spot rate                                  £:$       1.8625 – 1.8635

1 month forward                                   0.60 – 0.58 cts premium

3 months forward                                  1.80 – 1.75 cts premium

A 3 month currency option to buy US$4 million at an exchange rate of £1: $1.8625 – 1.8635 is currently costing £20 000.

 

Required                

Advice the company on the cheapest method to use.  


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Answer #1

(a)

Maturity          30 days          90 days          180 days        360 days

1)                    1,000,000

2)                                            500,000

3)                                                                                            30,000,000

4)                                            -500,000

5)                    500,000

6)                                                                    -8,000,000

7)                    -1,000,000

8)                                                                                             -10,000,000

9)                                                                     -3,000,000

Total               500,000         0                      -11,000,000      20,000,000



answered by: Bijay Agrawal
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Answer #2

(b)

For 30 days, sell JPY 500,000 forward.

For 90 days, no hedging necessary.

For 180 days, buy JPY 11,000,000 forward.

For 360 days, sell JPY 20,000,000 forward.


answered by: Bijay Agrawal

> The above answer belongs to question 1 (b)

Bijay Agrawal Sat, Nov 13, 2021 6:16 AM

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