Question
In: Finance
Company Deemed, Inc., a US-based company, has sold its products to a Chinese Company. At the...
Company Deemed, Inc., a US-based company, has sold its products to a Chinese Company. At the spot rate of 1 USD = 7 CNY prevailing today the invoice value is 1 million USD. The company will pay in CNY in 90 days. The 90-day forward rate is 1USD = 7.1 CNY. The borrowing rates in US and China are 2% and 8%, respectively. The company’s cost of capital is 10%. The company has to decide between forward market hedge and money market hedge. Do the analysis and make a recommendation.
Please show EXCEL formulas as well.
Solutions
Expert Solution
FORWARD MARKET HEDGE:
Forward rate: 1 USD=7.1 CNY
Amount to be received (Sales Price)=7 million CNY(1million*7)
Amount in US dollar as per forward contract =(7/7.1)million USD=985,915 USD
Present Value of receipt at 10% discount for 3 months(90 days)=985915/1.025=$961,869
MONEY MARKET HEDGE:
Three months interest rate in China =(8/4)=2%
Three months interest rate in USA =2/4=0.5%
Borrow (7 million/1.02 )CNY in China.=6,862,745 CNY
Convert into US dollar at current spot rate (1USD=7CNY)
Amount of USD =(6862745/7)=$980,392
Invest in USA at 2%
Amount to be received after three months =980392*1.005=$985,294
Present Value of receipt at 10% discount =985294/1.025=$961,263
Amount Payable on borrowing in China=6862745*1.02=7 million
This amount will be paid from the amount to be received from the Chinese Company
| Present Value of receipt | |
| FORWARD MARKET HEDGE | $961,869 |
| MONEY MARKET HEDGE | $961,263 |
| Forward Market Hedge Recommended |
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