Question

3. Maruti Suzuki Ltd. has imported machinery worth 1 million USD and the invoice is payable in 90 days. Current Spot rate in the market is USD/INR 75 while 90 Days forward is quoted at USD/INR 76. The prominent economists predict the spot rate after 90 days at USD/INR 76.5. Cost of Borrowing for Maruti in India is 10% and USD Interest Rate = 2%. A 90 days Call option with exercise price of USD/INR 75 for 100,000 USD is available at premium of INR 2. You are required to calculate impact on transaction exposure under following scenarios:

a. Company decides to use Forwards & Options for hedging

b. Company decides to use Money Market hedging

Answer 1

a) The import bill is $1 million payable after 90 days

Using forwards, the rate of purchase of $1 million can be fixed at Rs.76/$ and hence the transaction exposure will be completely converted to Rupee from $. and the transaction exposure will now be

Rs. 76 million instead of USD 1 million

If call options are used Rs.2 has to be paid to get the option to purchase USD 1 at Rs.75

Thus total premium paid = $1 million * Rs.2/$ = Rs.2 million

and the maximum price one has to pay to purchase $1 will be Rs. 75 , So the maximum price (including premium) which may be paid is Rs.77/$ , thus total transaction exposure is maximum Rs.77 million or lower.

b) With money market hedging, Maruti Suzuki has to borrow Rupee at 10% and convert it to USD and deposit so that it matures to $ 1 million after 90 days

Amount to be deposited in USD = present value of USD 1 million

= USD 1/(1+0.02*90/360) million

= USD 0.99502488 or USD 995,024.88

Equivalent amount of Rupees needed to be borrowed today = 75*995024.88 = Rs.74.6268657 million

So, liability in Rupee after 90 days = 74.6268657*(1+0.10*90/360) = Rs.76.49254 million

So, the effective Exchange rate fixed is Rs.76.49254/$

and the transaction exposure fixed at Rs.76.49254 million in Money market hedging