In: Finance
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)
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.