Question

.No.1: It is the end of September 2018. The current PKR/USD exchange rate is
135.26, the Pakistani and US three-month interest rates are 6% and 4.5% per annum
respectively. A forecast indicates that the exchange rate at the end of 2018 will be 128.50.
a) What would you do based on this information if you expect to receive USD 50000 at
the end of year 2008?
b) If the actual exchange rate turns out to be 136.50, calculate the percentage forecasting
error.
c) If you expect a forward contract for end of 2018 at an exchange rate 132.75, will you
hedge it or not?
d) Based on answer in part c), how much profit/loss was incurred by acting on this
forecast? (Marks 06

Answer 1

.a) HEDGING USD 50000 RECEIVABLE

Strategy based on the information available

MONEY MARKET HEDGE:

3 months interest in USA =4.5%=0.045

STEP 1 :Borrow Present Value of USD 50000 =50000/1.045= $47,846.89USD in USA

STEP2: Convert US dollar to Pakistani Rupee (PKR)at current spot rate of PKR135.26/USD

Amount received =47846.89*135.26= PKR 6,471,770.33

STEP 3: Invest PKR 6,471,770.33 at Three monthly interest of 6%

Amount Received at end of Three months = PKR 6,471,770.33*1.06= PKR 6,860,076.56

STEP4: Amount of $ 50,000 USD received after 3 months will be used to clear the debt in USD including interest

Net amount received at end of three months = PKR 6,860,076.56

Effective exchange rate= (6,860,076.56/50000)PKR/USD=137.20PKR/USD

b) PERCENTAGE FORECASTING ERROR:

(136.50/128.50)-1=0.062256809

Forecasting Error in Percentage=6.23%( rounding to two decimal places)

c) If Forward rate =132.75

Expected exchange rate at end of 2018=128.50

Yes, we should hedge . Hedging will ensure getting a rate of 132.75

d)Amount of profit for forward hedging =PKR 50000*(132.75-128.50)=   PKR 212,500