Assume you purchase raw materials worth 5 million GHS from a company in Ghana. You have...
Assume you purchase raw materials worth 5 million GHS from a company in Ghana. You have negotiated credit terms that allow you to make payment in 180 days. The spot exchange rate is 1 USD = 5 GHS. However, you are concerned that the currency of Ghana may appreciate in the future and increase your cost of raw materials in dollar terms. You have been unable to find a bank willing to enter into a forward contract with you. There are no options available either. How can you hedge your risk. Interest rates in US and Ghana are 3% and 2%, respectively. The cost of capital for the firm is 9%. Explain your logic in words. Show math. Provide complete answer supported by logic and analysis.
Homework Answers
IN the given situation, Hedging can be done by Money Market Hedge.
It is the method of creating an asset or a liability in the currency that is either payable or receivable.
Steps for Money Market Hedge:
Liability after 180 days = 5000000 GHS
Interest Rate for GHS = 2%
Therefore, we should invest 5000000/1.01 = 4950495.05 GHS TODAY to receive 5000000 GHS after 180 days
Today
1) Buy 4950495.05 for 4950495.05/5 = $990099.01
2) Invest GHS 4950495.05 for 180 days
After 180 days
3) Realize the investment proceeds with interest = 4950495.05*1.01 = 5000000 GHS
4) Pay the liability of 5000000 GHS
By undergoing above mentioned hedge, the company can eliminate its FOREIGN EXCHANGE FLUCTUATION RISK. It has locked its exposure at $990099.01 in today's terms and at 990099.01*(1.045) = $1034653.47 after 180 days.
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