In: Finance
Assume that a U.S. firm expects to make a payment of SF3,500,000 in 6 months and wants to execute a money market hedge. The following information is available: U.S. borrowing interest rate = 5%; U.S. lending interest rate = 4%; Swiss borrowing interest rate = 8%;Swiss lending interest rate = 6%; Spot rate is $0.95/SF; The U.S. firm's weighted average cost of capital (WACC) is 10%. Explain very well if the U.S. firm intends to use the money market hedge to cover the payment of SF2,500,000, what shall it do, and what will be the total cost in USD in 6 months?
1] | The strategy is to create an SF asset that | |
will have a maturity value of SF3500000 in | ||
6 months time. For that, an SF deposit should | ||
be made by borrowing in $. The steps involved | ||
are: | ||
Amount of deposit to be made in SF = 3500000/1.03 = | SF 3,398,058 | |
Amount to be borrowed in $ to enable the | ||
deposit in SF = 3398058*0.95 = | $ 3,228,155 | |
2] | Actions to be taken today: | |
Borrow $3,228,155 at 2.5% [6 months rate]. The | ||
total amount to be repaid = 3228155*1.025 = | $ 3,308,859 | |
Convert the above $ into SF3,398,058 and | ||
invest it at 3% [half year rate] to get after 6 | ||
months SF3,500,000. | ||
3] | Actions to be taken after 6 months: | |
Realize the SF deposit having a value of | ||
SF3,500,000 and pay the amount due of | ||
SF3,500,000. | ||
Settle the borrowing in $ by paying, along with | ||
interest the amount of $3,308,859. | ||
4] | The total cost in USD = $3,308,859 [the total | |
cost of borrowing in USD] |