Question

The existing spot rate of the Singapore dollar is $.62. The one‑year forward rate of the Singapore dollar is $.61. The probability distribution of the future spot rate in one year is forecasted as follows:

                  Future Spot Rate                                     Probability

                          $.60                                                         25%

                            .63                                                         45

                            .65                                                         30

Assume that one‑year put options on Singapore dollars are available, with an exercise price of $.64 and a premium of $.04 per unit. One‑year call options on Singapore dollars are available with an exercise price of $.61 and a premium of $.02 per unit. Assume the following money market rates:

                                                      U.S.                 Singapore

            Deposit rate                        6%                         5%

            Borrowing rate                   8                            7

1. Assume that ABC Co. will need to pay 500,000 Singapore dollars in one year. Given the above relevant information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate. Then compare the most appropriate hedge to an unhedged strategy and decide whether ABC Co. should hedge its receivables position. Please provide detailed explanation to your answers.
2. Assume that XYZ Inc. expects to receive 1 million Singapore dollars in one year. Given the above relevant information, determine whether a forward hedge, a money market hedge, or a currency options hedge would be most appropriate. Then, compare the most appropriate hedge to an unhedged strategy, and decide whether XYZ Inc. should hedge its payables position. Please provide detailed explanation to your answers.

Please the answer of the big problem with detailed explanations.

Answer 1

(1) Calculation without receivable

Sr.No.	Particular	Amount	Amount
	Without Hedge
	Payable	SGD           500,000.00
	Future Spot Rate	$                         0.6285
	($0.60 x 25% + $0.63 x 45% + $0.65 x30%)
	Payabale without hedge		$        314,250.00
1	Hedge via Forward
	Payable	SGD           500,000.00
	Forward Rate	$                         0.6100
	Payable in Forward Contract		$        305,000.00
2	Hedge via Money Market Hedge
	Payable	SGD           500,000.00
	(A) Today Borrow Money from US equivelent to SGD 500,000 after 1-Year including interest (Invest in Singapur)	$                 295,238.10
	(SGD 500,000 /1.05) x $0.62
	Interest on above borrowing @8% for 1-Year	$                   23,619.05
	Payable in Money Market Hedge		$        318,857.14
3	Hedge via Call Option
	Payable	SGD           500,000.00
	Option exercised so buy at $0.61	$0.61
	Total		$        305,000.00
	Add :
	Call Premium Paid	$                   10,000.00
	Add : Interest cost	$                         800.00
	($10,000 x 8% x 12/12)
	Total Cost on Call Option		$          10,800.00
	Payable in call option hedge		$        315,800.00

Advisable to hedge through future as it has lowest outflow i.e. $305,000

(2) If firm have receivable SGD 1,000,000 it means company need to hedge receivable.

Sr.No.	Particular	Amount	Amount
	Without Hedge
	Receivable	SGD       1,000,000.00
	Future Spot Rate	$                         0.6285
	($0.60 x 25% + $0.63 x 45% + $0.65 x30%)
	Receivable without hedge		$        628,500.00
1	Hedge via Forward
	Receivable	SGD       1,000,000.00
	Forward Rate	$                         0.6100
	Receivable in Forward Contract		$        610,000.00
2	Hedge via Money Market Hedge
	Receivable	SGD       1,000,000.00
	(A) Today Borrow Money from Singapore equivelent to SGD 1,000,000 after 1-Year including interest (Borrow in Singapur)	SGD           934,579.44
	(SGD 1,000,000 /1.07)
	Exchange rate (Spot)	$                              0.62
	Money received in $	$                 579,439.25
	Interest on above Invest in US @6% for 1-Year	$                   34,766.36
	Receivable in Money Market Hedge		$        614,205.61
3	Hedge via Call Option
	Receivable	SGD       1,000,000.00
	Option exercised so buy at $0.64	$0.64
	Total		$        640,000.00
	Less :
	Put Premium Paid	$                   40,000.00
	Add : Interest cost	$                     3,200.00
	($40,000 x 8% x 12/12)
	Total Cost on Call Option		$          43,200.00
	Payble in call option hedge		$        596,800.00

It is better to receivable if not hedge. i.e $628,500

Here for XYZ Inc. no data of paybale given but as we used the same data in both ABC Co. and XYZ Inc. so in payable forward contract have less outflow so better to hedge through future contract for net payble if payable higher than receivable otherwise net receivable advisable to not to hedge as it better to receivable as calculated above.

For understanding both company are differance so calculated individually so we can net of paybale and receivale.

Assumption : Future spot rate will be same as calculated based on probability given both option exercisable.