Question

Question text

Conroe Ltd expects to receive EUR 1 million in 6 months’ time. The following product rates are available:

• Spot is currently 0.5400 EUR /NZD
• 6-month forward rates are available at 0.5250/0.5370 EUR/NZD
• 6-month borrowing/investing rate for the company is 6% p.a. in NZD and 12% p.a. in EUR
• Assume the spot rate turns out to be 0.5200 EUR/NZD in 6-months

If a money market hedge is used, what NZD amount is received in 6-months?

Select one:

a. 1,905,789

b. 1,752,646

c. 1,799,441

d. 1,956,674

Answer 1

After 6 months of time, we are getting 1 milion EUR. There is a high degree of association of Foreign exchange risk.In order to eliminate this risk, one can use money Heding techinque

Step: Borrow present value of 1 million EUR today to pay it in the Future

Interest in EUR = 12%p.a or 6% for half years

Present value of 1 million EUR= 10,00000EUR/1.06

= 943396.22 EUR

So Borrow 943396.22 EUR today at an interest rate of 12% p.a

Loan balance after 6 months is= 943396.22*1.06=10,00000 EUR

So, we can borrow 943396 EUR and pay off 1 million EUR after 6 months.However , we are having receivable of 1 million EUR, to be received in 6 months of time, we can easily pay off the loan.

Now we are getting 943396.22 EUR, convert into NZD on spot rate

1 NZD = 0.5400 EUR

1 NZD/0.5400 EUR = 1 EUR

1 EUR = 1.85185 NZD

943396.22 EUR = 943396.22*1.85185 NZD

= 1747028.29 NZD

If we invest 1747028.29 NZD at an interest rate of 6% p.a or 3% for 6 months

Amount realized in NZD after 6 months = 1747028.29*1.03

= 1799440 NZD

So option C ) 1799441 NZD is the correct answer.