At this point, the demand in Mexico is picking up nicely. Your company is currently repatriating...

At this point, the demand in Mexico is picking up nicely. Your company is currently repatriating 47 million pesos per year from Mexico through the ESL class offering and English learning material sales. In addition your company is also importing Spanish learning material packages produced in Mexico and the company needs to pay about 7 million pesos a year from an independent subcontractor located in Mexico. Given recent exchange rate volatility increase, you are asked to identify a good alternative to hedge your company’s transaction exposure.

Based on the following information, please calculate the amounts you would have received based on the following information. You have alternatives of using forward hedge, money market hedge, futures and options. Based on your analysis and calculation, which hedging alternative will you recommend?


	Summary of market information

Spot rate	Bid	Ask
	$.051	$0.06

Forward contract information	Bid	Ask
USD per peso	$0.047	$0.057

Money market rate information	Bid (borrowing)	Ask (lending)
Annual Interest rate for Peso	5.1%	7%
Annual Interest rate for USD	2.5%	3.7%

Option Information American Option 500,000 pesos per contract	Call option	Put option
Strike price ($)	$.0515	$.0515
Option premium (% of exercise price)	2%	2.5%
Option premium ($) per peso	0.00103	0.0012875
Total premium ($) per contract	$515	$643.75

Futures Contract Information	Bid	Ask
USD per peso 500,000 pesos per contract	$0.048	$ 0.058

Expert Solution

Net Remittance at spot rate
Repatriation      4,70,00,000.00
To be paid against import        (70,00,000.00)
Net Remittance in pesos      4,00,00,000.00
Spot Bid rate $                    0.051
Net Remittance in USD $      20,40,000.00
Option 1 Enter into Forward contract for purchasing USD after one year
Forward contract Bid Rate $                  0.0470
Net Remittance of pesos      4,00,00,000.00
Net Remittance in USD $      18,80,000.00
Foreign Exchange Loss
Remittance at spot rate $      20,40,000.00
Remittance in case of enter into forward contract $      18,80,000.00
Net Loss $        1,60,000.00
Option 2 Enter into Money market product
Strategy will be :
Borrow pesos now at lending rate and convert it into USD at spot rate and invest the converted amount in USD
Net proceeding out of borrowing
Borrowing amount (realisable value after one year)      4,00,00,000.00
Interest charge @ 7% per annum on lending        (28,00,000.00)
Net proceedings      3,72,00,000.00
Convert into USD at spot rate @0.051 $      18,97,200.00
Invest in USD and earn interest @ 2.5% $            47,430.00
Total proceedings at the yearend $      19,44,630.00
Foreign Exchange Loss
Remittance at spot rate $      20,40,000.00
Remittance in case money market product used $      19,44,630.00
Net Loss $            95,370.00
Option 3 Buy put option contract for selling pesos after one year @ 0.0515
No of pesos per contract            5,00,000.00
No of Contract (40000000/500000)                        80.00
Premium amount $643.75 per contract $         (51,500.00)
Proceedings at year end @ 0.0515 $      20,60,000.00
Net proceedings net of premium $      20,08,500.00
Foreign Exchange Loss
Remittance at spot rate $      20,40,000.00
Remittance in case money market product used $      20,08,500.00
Net Loss $            31,500.00
Option 4 Entering into a future contract to buy USD at bid rate $ 0.048 per peso
Net proceedings in case of entering into future contract        19,20,000.000
Foreign Exchange Loss
Remittance at spot rate $      20,40,000.00
Remittance in case money market product used $      19,20,000.00
Net Loss $        1,20,000.00
Answer : Option 3 i.e. Buying put option contract is best option amoungst all option availble as foreign exchange hedging loss is lowest in case of this hedging option

	Net Remittance at spot rate
	Repatriation	4,70,00,000.00
	To be paid against import	(70,00,000.00)
	Net Remittance in pesos	4,00,00,000.00
	Spot Bid rate	$ 0.051
	Net Remittance in USD	$ 20,40,000.00

Option 1	Enter into Forward contract for purchasing USD after one year
	Forward contract Bid Rate	$ 0.0470
	Net Remittance of pesos	4,00,00,000.00
	Net Remittance in USD	$ 18,80,000.00
	Foreign Exchange Loss
	Remittance at spot rate	$ 20,40,000.00
	Remittance in case of enter into forward contract	$ 18,80,000.00
	Net Loss	$ 1,60,000.00

Option 2	Enter into Money market product
	Strategy will be :
	Borrow pesos now at lending rate and convert it into USD at spot rate and invest the converted amount in USD


	Net proceeding out of borrowing
	Borrowing amount (realisable value after one year)	4,00,00,000.00
	Interest charge @ 7% per annum on lending	(28,00,000.00)
	Net proceedings	3,72,00,000.00
	Convert into USD at spot rate @0.051	$ 18,97,200.00
	Invest in USD and earn interest @ 2.5%	$ 47,430.00
	Total proceedings at the yearend	$ 19,44,630.00
	Foreign Exchange Loss
	Remittance at spot rate	$ 20,40,000.00
	Remittance in case money market product used	$ 19,44,630.00
	Net Loss	$ 95,370.00

Option 3	Buy put option contract for selling pesos after one year @ 0.0515
	No of pesos per contract	5,00,000.00
	No of Contract (40000000/500000)	80.00
	Premium amount $643.75 per contract	$ (51,500.00)
	Proceedings at year end @ 0.0515	$ 20,60,000.00
	Net proceedings net of premium	$ 20,08,500.00
	Foreign Exchange Loss
	Remittance at spot rate	$ 20,40,000.00
	Remittance in case money market product used	$ 20,08,500.00
	Net Loss	$ 31,500.00

Option 4	Entering into a future contract to buy USD at bid rate $ 0.048 per peso
	Net proceedings in case of entering into future contract	19,20,000.000
	Foreign Exchange Loss
	Remittance at spot rate	$ 20,40,000.00
	Remittance in case money market product used	$ 19,20,000.00
	Net Loss	$ 1,20,000.00

Answer :	Option 3 i.e. Buying put option contract is best option amoungst all option availble as foreign exchange hedging loss is lowest in case of this hedging option

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