Busco has a foreign-currency denominated payable, it can hedge by buying the foreign currency payable forward. The company can expect to eliminate the exposure without incurring costs as long as the forward exchange rate is an unbiased predictor of the future spot rate. Busco exported an A380 to a UK company, and was billed the sum of £ 12,000,000 payable in three months. Currently the spot rate is $1.40/£ and the three-month forward rate is $1.36/£.The three-month money market interest rate is 12% per annum in US and 8% per annum in UK.So the management of Busco decided to manage this transaction exposure and use the money market hedge to deal with this pound account payable.
Busco has a foreign-currency denominated payable, it
can hedge by buying the foreign currency payable
forward. The company can expect to eliminate the
exposure without incurring costs as long as the forward
exchange rate is an unbiased predictor of the future spot
rate. Busco exported an A380 to a UK company, and was
billed the sum of £ 12,000,000 payable in three months.
Currently the spot rate is $1.40/£ and the three-month
forward rate is $1.36/£.The three-month
interest rate is 12% per annum in US and 8% per annum
in UK.So the management of Busco decided to manage
this transaction exposure and use the money market
hedge to deal with this pound account payable.
1)Conduct a cash flow analysis of the money market hedge.
Answer:
|
Transaction |
Current cash flow |
(3-month) Cash flow at maturity |
|
|
1 |
Borrow £ |
=£11,764,705.88
|
- £12,000,000 |
|
2 |
Buy $ spot with £ |
= $16, 470,588.24
- £11,764,705.88 |
0 |
|
3 |
Invest in US |
- $16, 470,588.24 |
=$16,964,705.89 |
|
4 |
Connect £ with receivable |
0 |
£12,000,000 |
|
5 |
Calculate Net cash flow |
0 |
$16,964,705.89 |
2) Compare and contrast the cash flow at maturity and
the net dollar proceeds if instead the options market
hedge is used by Airbus. You may assume a put option
of £ 12,000,000 with an exercise price of $1.36/£ with
a three-month expiration and an option premium of $
0.05 per £.
*Can you please answer the question 2.
Step by step
Solved in 4 steps
