Question

you expect to receive ZAR1 000 000.00 in 3 months time but you are worried about adverse movements (a strengthening dollar) in exchange rates and want to hedge against this; you gather the following information from the money and foreign exchange markets

spot exchange rate $1.7640/ZAR

Three month forward rate $1.7540/ZAR

Forecast spot exchange rate 3 months from now $1.7400/ZAR

Zimbabwe 3month borrowing interest 8%

Zimbabwe's 3 month deposit interest rate 6%

South Africa's 3 month borrowing interest rate 10%

South Africa's 3 month deposit interest rate 8%.

Show how you can hedge against the currency risk using money market hedge.

Answer 1

The US Company will Borrow ZAR 1000000, present value at ZAR borrowing Rate of 8%
Amount borrowed= ZAR 1000000/1.08
Amount borrowed= ZAR 925925.9
After 3 months the loan amount including interest will be ZAR 1000000
Amount borrowed of ZAR 925925.9 will be converted to USD at Spot Rate, $1.764/ZAR
Thus, amount of South African $ Received= $1633333
Amount of South African $ 1633333 received will be placed in investment at the rate of 8%
Thus amount received after 3 months will be = $1633333*1.08
Amount Received =$1764000
Amount of ZAR received after 3 months will be used to pay off loan amount of ZAR 1000000.
And Amount received from investment will be $1764000.
Thus, rate of $1.764/ZAR will be maintained, and company will get $1764000, instead of $1740000, and avoid a forex loss