American Airlines is trying to decide how to go about hedging Sfr 70m in ticket sales...

American Airlines is trying to decide how to go about hedging Sfr 70m in ticket sales receivable in 180 days. Suppose it faces the following exchange and interest rates (first rate for borrowing, second for investing)

Spot rate $0.6433-42/SFr
Forward rate (180 days) $0.6578-99/SFr
SFr 180 day interest rate (annualized) 01%-3.97%
US $ 180 day interest rate (annualized) 01%-7.98%

What is the hedged value of American’s ticket sales using Forwards?
What is the hedged value of American’s ticket sales using Money Market?
. Choose the best (Forward or Money Market)

Solutions

Expert Solution

hedged value of American’s ticket sales using Forwards = Amount receicable * Forward rate

=SFR 70 m *$0.6578 i.e. $46.046 m

$0.6578/SFR is used since we are selling SFR and buying $.

hedged value of American’s ticket sales using Money Market

SFR rate of borrowing for 180 days = 3.97%*180/365 i.e. 1.957%

Borrowing PV of SFR 70 m today , such that after 180 days we will pay SFR 70 m = SFR 70m/1.019578

= SFR 68.655m

The above loan will be paid through the amount which we received after 180 days.

The amount of SFR 68.655 m will be converted today using spot rate =SFR 68.655m *0.6433

= $44.165 m

$ rate of Investing for 180 days = 7.97%*180/365 i.e. 3.93% or 0.0393

Amount converted today will be invested for 180 days = Amount *(1+rate)

=$44.165m *(1+0.0393)

= $45.90 m

hedged value of American’s ticket sales using Money Market =$45.90m.

Forward rate is better since the amount received in US dollar is higher.

jeff jeffy answered 1 year ago

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