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1. Money Market Hedge on Receivables. Assume that Stevens Point Co. has net receivables of 100,000 Singapore dollars in 90 days.  The spot rate of the S$ is $.50, and the Singapore interest rate is 2% over 90 days.  Suggest how the U.S. firm could implement a money market hedge.  Be precise.

ANSWER: The firm could borrow the amount of Singapore dollars so that the 100,000 Singapore dollars to be received could be used to pay off the loan.  This amounts to (100,000/1.02) = about S$98,039, which could be converted to about $49,020 and invested.  The borrowing of Singapore dollars has offset the transaction exposure due to the future receivables in Singapore dollars.

2. Money Market Hedge on Payables. Assume that Hampshire Co. has net payables of 200,000 Mexican pesos in 180 days.  The Mexican interest rate is 7% over 180 days, and the spot rate of the Mexican peso is $.10.  Suggest how the U.S. firm could implement a money market hedge.  Be precise.

ANSWER: If the firm deposited MXP186,916 (computed as MXP200,000/1.07) into a Mexican bank earning 7% over 6 months, the deposit would be worth 200,000 pesos at the end of the sixmonth period.  This amount would then be used to take care of the net payables.  To make the initial deposit of 186,916 pesos, the firm would need about $18,692 (computed as 186,916 × $.10).  It could borrow these funds.

3. Hedging with Forward Contracts. Explain how a U.S. corporation could hedge net receivables in Malaysian ringgit with a forward contract.

Explain how a U.S. corporation could hedge payables in Canadian dollars with a forward contract.

ANSWER: The U.S. corporation could sell ringgit forward using a forward contract.  This is accomplished by negotiating with a bank to provide the bank ringgit in exchange for dollars at a specified exchange rate (the forward rate) for a specified future date.

The U.S. corporation could purchase Canadian dollars forward using a forward contract.  This is accomplished by negotiating with a bank to provide the bank U.S. dollars in exchange for Canadian dollars at a specified exchange rate (the forward rate) for a specified future date.

4. Benefits of Hedging. If hedging is expected to be more costly than not hedging, why would a firm even consider hedging?

ANSWER: Firms often prefer knowing what their future cash flows will be as opposed to the uncertainty involved with an open position in a foreign currency.  Thus, they may be willing to hedge even if they expect that the real cost of hedging will be positive

5. Hedging Payables. Assume the following information:

90day U.S. interest rate = 4%

90day Malaysian interest rate = 3%

90day forward rate of Malaysian ringgit = $.400

Spot rate of Malaysian ringgit = $.404

Assume that the Santa Barbara Co. in the United States will need 300,000 ringgit in 90 days.  It wishes to hedge this payables position.  Would it be better off using a forward hedge or a money market hedge?  Substantiate your answer with estimated costs for each type of hedge.

ANSWER: If the firm uses the forward hedge, it will pay out 300,000($.400) = $120,000 in 90 days.

If the firm uses a money market hedge, it will invest (300,000/1.03) = 291,262 ringgit now in a Malaysian deposit that will accumulate to 300,000 ringgit in 90 days.  This implies that the number of U.S. dollars to be borrowed now is (291,262 × $.404) = $117,670.  If this amount is borrowed today, Santa Barbara will need $122,377 to repay the loan in 90 days (computed as $117,670 × 1.04 = $122,377).

In comparison, the firm will pay out $120,000 in 90 days if it uses the forward hedge and $122,377 if it uses the money market hedge.  Thus, it should use the forward hedge.

6. Hedging Decision on Receivables. Assume the following information:

180day U.S. interest rate = 8%

180day British interest rate = 9%

180day forward rate of British pound = $1.50

Spot rate of British pound = $1.48

Assume that Riverside Corp. from the United States will receive 400,000 pounds in 180 days.  Would it be better off using a forward hedge or a money market hedge?  Substantiate your answer with estimated revenue for each type of hedge.

ANSWER: If the firm uses a forward hedge, it will receive 400,000($1.50) = $600,000 in 180 days.

If the firm uses a money market hedge, it will borrow (400,000/$1.09) = 366,972 pounds, to be converted to U.S. dollars and invested in the U.S.  The 400,000 pounds received in 180 days will pay off this loan.  The 366,972 pounds borrowed convert to about $543,119 (computed as 366,972 × $1.48), which when invested at 8% interest will accumulate to be worth about $586,569.

In comparison, the firm will receive $600,000 in 180 days using the forward hedge, or about $586,569 in 180 days using the money market hedge.  Thus, it should use the forward hedge

7. Currency Options. Relate the use of currency options to hedging net payables and receivables.  That is, when should currency puts be purchased, and when should currency calls be purchased? Why would Cleveland, Inc., consider hedging net payables or net receivables with currency options rather than forward contracts?  What are the disadvantages of hedging with currency options as opposed to forward contracts?

ANSWER: Currency call options should be purchased to hedge net payables.  Currency put options should be purchased to hedge net receivables.

Currency options not only provide a hedge, but they provide flexibility since they do not require a commitment to buy or sell a currency (whereas the forward contract does). 

A disadvantage of currency options is that a price (premium) is paid for the option itself.  The only payment by a firm using a forward contract is the exchange of a currency as specified in the contract.

8. Forward versus Options Hedge on Payables. If you are a U.S. importer of Mexican goods and you believe that today’s forward rate of the peso is a very accurate estimate of the future spot rate, do you think Mexican peso call options would be a more appropriate hedge than the forward hedge? Explain.

ANSWER: If the forward rate is close to or exceeds today’s spot rate, the forward hedge would be preferable because the call option hedge would require a premium to achieve about the same locked-in exchange rate. If the forward rate was much lower than today’s spot rate, the call option could be preferable because the firm could let the option expire and be better off.

9. Forward versus Options Hedge on Receivables. You are an exporter of goods to the United Kingdom, and you believe that today’s forward rate of the British pound substantially underestimates the future spot rate. Company policy requires you to hedge your British pound receivables in some way. Would a forward hedge or a put option hedge be more appropriate? Explain.

ANSWER: A put option would be preferable because it gives you the flexibility to exchange pounds for dollars at the prevailing spot rate when receiving payment.