Question

(4)Consider the following information: .2.5% 90-day forward rate for the pound.. ..........$1.50 Spot rate for the pound.............................51.52 (a)Assume that CSI company based in the US will receive 1,000,000 pounds in 90 days, would it be better off using the forward hedge or money market hedge? Substantiate your answer with appropriate quantitative evidence. (b)Assume that the same CSI company will need 1000,000 pounds in 90 days and wishes to hedge its payables position. Would you recommend a forward hedge or a money market hedge? Explain your answer with relevant quantitative support.

Answer 1

4)
a)	Forward hedge:
	Amount receivable under the forward hedge = 1000000*1.5 =	$    15,00,000
	MMH:
	The strategy is to set up a liability in GBP such that
	its MV after 90 days would be 1000000 GBP.
	For this borrowing is to be made in GBP equivalent
	to 1000000/1.03 =	£      9,70,874
	The GBP is to be converted at today's spot to get 970874*1.52 =	$    14,75,728
	The dollars so obtained would be invested for 90 days to get 1475728*1.025 =	$    15,12,621
	The above amount would be the final receipt in $
	against the receivable
	DECISION:
	As the receipt in dollars would be more under the
	MMH, it should be preferred.
b)	Forward hedge:
	Amount payable under the forward hedge = 1000000*1.5 =	$    15,00,000
	MMH:
	The strategy is to set up an asset in GBP such that
	its MV after 90 days would be 1000000 GBP.
	For this a lending is to be made in GBP equivalent
	to 1000000/1.03 =	£      9,70,874
	The funds for the lending would be obtained by getting a $ loan for 90 days. The loan required would be = 970874*1.52 =	$    14,75,728
	The dollar loan so obtained has to be repaid with interest for 90 days, the total amount being 1475728*1.025 =	$    15,12,622
	The above amount would be the final payment in $
	against the liability.
	DECISION:
	As the payment in dollars would be less under the
	Forward hedge, it should be preferred.