A United Kingdom firm is planning to hedge an import payment of USD 10 million dollars...

A United Kingdom firm is planning to hedge an import payment of USD 10 million dollars due in 9 months (i.e. the firm will expect to pay the US $10 million in 9 months-time). The spot rate is 1 UK = 1.25 USD. Note: UK = UK pounds. USD = US Dollars. The 9-month forward rate is 1 UK = 1.2575 USD. The nine-month interest rate for borrowing (and lending) in the United Kingdom (UK) is 1.00% p.a. and in the United States (US) is 2.60% p.a. respectively. All interest rates are continuously compounded rates. Required: What is the best way for the company to hedge its future USD payment or cash outflow? Of the two possible alternative options to hedge the USD payment how much better off in UK pounds are you under the best option at time t = 9 months hence? Assume the firm can borrow or lend UK pounds and / or US dollars at the interest rates quoted above and also transact at the quoted spot and forward rates. If necessary state any other assumptions you make.

a. option one .. option two .. b. How much better off in UK pounds are you under the best option at time t = 9 months hence?

Solutions

Expert Solution

There are two options available:

1. Hedging through Forward contracts

2. Money market hedging

Opton 1: Hedging through Forward contracts

Forward rate, F: 1 UK = 1.2575 USD.

Hence, total outflow towards import payments in terms of UK pounds = Payable / F = USD 10,000,000 / (USD 1.2575 / UK) = UK 10,000,000 / 1.2575 = UK 7,952,286

Option 2: Money market hedging

No arbitrage forward rate under money market, FNA = Se(rUS - rUK) x t = USD 1.25 x e(2.60% - 1.00%) x 9/12

= USD 0.9526 / UK

Hence, the total outflow towards import payments in terms of UK pounds = Payable / FNA = USD 10,000,000 / (USD 0.9526 / UK) = UK 10,000,000 / 0.9626 = UK 10,497,358

Hece, the answers should be:

a. option one: UK 7,952,286

option two: UK 10,497,358

b. How much better off in UK pounds are you under the best option at time t = 9 months hence?

You are better of in option one and you are better off by 10,497,358 -7,952,286 = UK 2,545,072 under the best option at time t = 9 months hence

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Aldi is forecasting next year’s turnover at USD 70 million. The firm is planning to maintain a 47%

Aldi is forecasting next year’s turnover at USD 70 million. The firm is planning to maintain a 47% dividend pay-out ratio and is expecting a profit margin of 15%. Calculate the projected rise in retained earnings and explain the company’s three main options for raising new growth funding.

On June 15, a US firm is planning to import Mexican caviar worth Pesos 2 million...

On June 15, a US firm is planning to import Mexican caviar worth Pesos 2 million due on July 15 (one month later). The firm decides to hedge its payables position by using September peso futures. The spot rate on June 15 is US$ 0.0630 / peso and the September futures price on June 15 is at $0.0665 per peso. One month late on July 15, the spot rate is $0.0570 / peso while the September futures price is $0.0615...

-You have an import payment in CHF. You are maintaining USD account with ABC Bank. Inter...

-You have an import payment in CHF. You are maintaining USD account with ABC Bank. Inter Bank spot rate for USD/CHF – 0.9974/98. What will be the rate quoted by the bank for your import transaction in CHF. -Your export payment in USD has come to the bank. You want to convert this USD into INR. Spot rate USD/INR =: 67.76/78.17. At what price will the USD be converted to INR. Bank may load profit margin of 5 paise. -You...

In the Kingdom of Westeros suppose money supply is $0.5 million, nominal GDP is $10 million,...

In the Kingdom of Westeros suppose money supply is $0.5 million, nominal GDP is $10 million, and real GDP is $5 million during this year. Calculate the price level and the velocity of money for Westeros this year. Suppose velocity is constant and the Westerosi economy grows in real terms by 5% next year. What will happen to nominal GDP and the price level if the central bank in Westeros keeps the money supply constant? Please explain your answer briefly....

Your company is planning to borrow $1.5 million on a 3-year, 10%, annual payment, fully amortized...

Your company is planning to borrow $1.5 million on a 3-year, 10%, annual payment, fully amortized term loan. What fraction of the payment made at the end of the second year will represent repayment of principal? Round your answer to two decimal places.

Your company is planning to borrow $3 million on a 5-year, 10%, annual payment, fully amortized...

Your company is planning to borrow $3 million on a 5-year, 10%, annual payment, fully amortized term loan. What fraction of the payment made at the end of the second year will represent repayment of principal? Do not round intermediate calculations. Round your answer to two decimal places

Amazon's third-largest market is the United Kingdom. In 2019, the employees at a local firm in...

Amazon's third-largest market is the United Kingdom. In 2019, the employees at a local firm in London received their salary and decided to spend a portion of it on making online purchases from Amazon. The probability that the online purchases will be shipped on time to each employee is 0.68. Determine the following: a. The probability that three products will be shipped on time. b. The probability that out of three, two products will be shipped on time.

Suppose that the one-year interest rate is 10 percent in the United Kingdom. The expected annual...

Suppose that the one-year interest rate is 10 percent in the United Kingdom. The expected annual rate of inflation for the coming year is 4 percent for the United Kingdom and 7 percent for Switzerland. The current spot exchange rate is £:SFr = 3.75. Using the precise form of the international parity relations, compute the one-year interest rate in Switzerland, the expected Swiss franc to pound exchange rate in one year, and the one-year forward exchange rate.

A public company is planning to raise 3.2 million dollars by using financial instruments for a...

A public company is planning to raise 3.2 million dollars by using financial instruments for a seven-month project. Assume you work as a financial advisor, which instrument you would suggest the company to issue or purchase? Is the instrument you suggest a money market instrument or capital market instrument? Explain the reason(s). Discuss at least two reasons (differences) why the instrument you suggested in part (a) may trade at a different yield to a 10-year treasury bond.

A machine is purchased for $2 million dollars with a monthly loan payment lasting 3 years.

A machine is purchased for $2 million dollars with a monthly loan payment lasting 3 years. With a nominal interest rate at 4%, what is the balance due after 22 months?

Subjects