Practice problems for Module 4 ABC Corporation negotiated a forward contract to sell C$100,000 in one year at a forward rate of C$1=$0.80. On the delivery date, the spot rate was C$1=$0.83. How much is the revenue ABC Corporation can get from the forward hedge? Answer: Revenue from the forward hedge= C$100,000*C$0.80/$ = $80,000 ABC Corporation earns almost $80,000 in revenue through the forward hedge. What is the real cost of hedging receivables for this U.S. firm? Answer: Hedging of Real cost = Revenue without hedging less revenue with hedging = $(100,000*)-$80,000 = $3000 For this U.S. company, the actual cost of hedging receivables is $3000, which is the contract's cost. Given the following additional information Future Spot rate RCHr Prob. 0.78 -2000 0.20 0.81 1000 0.50 0.83 3000 0.30 What is the probability that the forward hedge will result in higher revenue than no border? How much is E(RCHr)? Overall, is forward hedge preferred? Answer: E(RCHr) = (-2000*0.20) + (1000*0.50) + (3000*0.30) =1000 In higher revenue than no hedge Profibility that forward hedge will result = Expected future spot rates is less than the forward rate (Nil) With hedge revenue = E(RCHr) * 0.83 = 1000*0.83=$830 Without hedge revenue= (-2000*0.20*0.78) + (1000*0.50*0.81) + (3000*0.30*0.83) = $840 Revenue with hedge is less than expected revenue without hedge that’s why overall hedge is not preferred. Lora Corp. needs NZ$100,000 in 180 days. The 180-day forward rate is NZ$1=$.52. Spot rate Prob. $0.40 5% 0.45 10% 0.48 30% 0.50 30% 0.53 20% 0.55 5% What is the probability that the forward hedge will result in higher cost than no border? How much is E(RCHp)? Overall, is forward hedge preferred? NZ$1 is the forward obtainable = $0.52. Hedge rate more significant than the forward rates therefore add all the probabilities of the 180 day. In this case forward hedge will cost higher than no border there is a 75% probability. NZ $ Probable spot rate Probability 100000 NZ $ hedging nominal cost 100000 NZ $ price of unhedged 100000$ * Spot rate Hedging real cost subtract unhedged cost - nominal 0.4 5% 52000 40000 12000 0.45 10% 52000 45000 7000 0.48 30% 52000 48000 4000 0.5 30% 52000 50000 2000 0.53 20% 52000 53000 -1000 0.55 5% 52000 55000 -3000 We can calculate E(RCHp) depend on the above calculations: 5%*($12,000) + 10%*($7000) +30%*($4,000) + 30%*($2000) + 20%*(-$1000) + 5%*(-$3000) = $600 + $700 + $ 1200 +$600- $200- $150 = $2,750 Companies like to know their future cash outflows because of this forward hedge are preferred. Please use the following information to answer the next three questions about money market hedge: 90-day U.S. interest rate 4% 90-day Malaysian interest rate 3% 90-day MYR forward rate $.40 MYR spot rate $.404 Santa Barbara Co. will need 300,000 ringgits in 90 days. How much MYR do you need after currency conversion today? Requirement = 3,00,000 ringgit after 90 days. If forward rate is used USD needed = 3,00,000 * 0.4 = $1,20,000 How many U.S. dollars do you need to borrow today to get the amount of MYR you need? Today USD needed = ($300000/1.03) *0.404 = $ 1,17,670 For 90 days, Malaysia's interest rate is 3%, Malaysian ringit today we will have to invest value. The said amount should then be sold spot. How many U.S. dollars do you need to pay off after 90 days? After 90 days US dollars needed to be paid off = $ 1,17,670*1.04 = $1,22,377 For 90 days interest rate in US is 4%, at the said rate for the 90 days we will borrow the dollars. Please use the following information to answer the next three questions about money market hedge: 180-day U.S. interest rate 8% 180-day British interest rate 9% 180-day pound forward rate $1.50 U.K. pound spot rate $1.48 Riverside Co. will receive 400,000 pounds in 180 days. How much foreign currency do you need today in a money market hedge? Requirements = 4,00,000 pounds in 180 days Foreign currency= 400000 * 0.8 = 320000 foreign currencies required today in money Market hedge. How many U.S. dollars do you receive from the currency conversion today? Today USD needed = ($400000/1.09) * 0.015 = $ 5504.58 For 90 days the interest rate in British is 9% How much will be available to Riverside Co. after 180 days? 5504.5871* 1.09= $6000 U.S. dollar will be available after 180 days.
