Question
It is now the end of August. A company headquartered in UK expects the following cash flows in euros at the end of the month
It is now the end of August. A company headquartered in UK expects the following cash flows in euros at the end of the month in three months time: Receipts 540,000 Payments 2,650,000 The company is concerned about the exposure to a risk of a movement in the sterling/euro exchange rate, and it has decided to hedge the exposure. It is considering three methods of hedging the exposure: (a) with a forward exchange contract (b) using a money market hedge (c) using currency futures Relevant data is as follows: FX rates /1 Spot 1.4538 1.4542
3 months forward 1.4443 1.4448
3-month interest rates Borrow Sterling (UK) 6.2%, Euro 3.8%; Invest 5.6%, Euro 3.4%. Currency futures Currency futures for sterling/euro are each for 100,000 and are priced in sterling.
Assume that the futures contracts mature at the end of the month and that when futures position is closed the basis is zero. Futures prices as at end of July are as follows: September futures 0.6890 December futures 0.6939
Required A. Advise the UK Company after having calculated the net cost in sterling of hedging the currency risk using: (a) a forward exchange contract [5 marks] (b) a money market hedge [11 marks] (c) currency futures. [14 marks]
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started