FOREX Question 13

Question 1

Forward Hedge

Answer 1

Receive £1,000,000 in 3 months
Sell £1,000,000 to US bank @ forward rate $1.754
Collect $1,754,000 in 3 months

Question 2

Money Market Hedge

Answer 2

Create liability by borrowing from UK bank
FV £1,000,000, PV=£1,000,000/(1+2.5%)
=975,610
Exchange @ spot rate $1.764 = $1,720,976
Save @ US bank for 3 months @1.5%
$1,720,976 x (1.05%) =$1,746,790
Eliminates the FOREX risk

Question 3

Options Hedge

Answer 3

3 month put option strike price $1.75, 1.5% premium
Clearing house charge:
1.5%x£1,000,000 x $1.764= $26,460
FV, given wacc 3% =26,460x1.03=27,254
If exercise $1,750,000 less 27,254
If don’t exercise lose premium and exchange at unknown rate