BUS330: International Finance 1) Money Market Hedge on Receivables

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BUS330: International Finance

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 Singapore dollar is A$0.95, and the Singapore interest rate is 2 per cent over 90 days. Suggest how the Australian company could implement a money market hedge. Be precise.

 

2. Money Market Hedge on Payables. Assume that Hampshire Co. has net payables of 200,000 Chinese yuan in 180 days. The Chinese interest rate is 7 per cent over 180 days, and the spot rate of the Chinese yuan is A$0.197. Suggest how the Australian company could implement a money market hedge. Be precise.
3. Net Transaction Exposure. Why should an MNC identify net exposure before hedging?
4. Hedging with Futures. Explain how an Australian company could hedge net receivables in euros with futures contracts. Explain how an Australian company could hedge net payables in Japanese yen with futures contracts.
5. Hedging with Forward Contracts. Explain how an Australian company could hedge net receivables in Malaysian ringgit with a forward contract.

Explain how an Australian company could hedge payables in New Zealand dollars with a forward contract.

6. Real Cost of Hedging Payables. Assume that the Australian company Loras Corp. imported goods from New Zealand and needs 100,000 New Zealand dollars 180 days from now. It is trying to determine whether to hedge this position. Loras has developed the following probability distribution for the New Zealand dollar:

 

Possible Value of

New Zealand Dollar in 180 Days	Probability
A$0.40	5%
A$0.45	10%
A$0.48	30%
A$0 .50	30%
A$0.53	20%
A$0.55	5%

 

The 180-day forward rate of the New Zealand dollar is A$0.94. The spot rate of the New Zealand dollar is A$0.91. Develop a table showing a feasibility analysis for hedging. That is, determine the possible differences between the costs of hedging versus no hedging. What is the probability that hedging will be costlier to the company than not hedging? Determine the expected value of the additional cost of hedging.

7. Benefits of Hedging. If hedging is expected to be costlier than not hedging, why would a company even consider hedging?
8. Real Cost of Hedging Payables. Assume that Suffolk Co. negotiated a forward contract to purchase 200,000 Malaysian ringgit in 90 days. The 90-day forward rate was A$0.3545 per Malaysian ringgit. The ringgit to be purchased was to be used to purchase Malaysian supplies. On the day the ringgits were delivered in accordance with the forward contract, the spot rate of the Malaysian ringgit was A$0.4045. What was the real cost of hedging the payables for this Australian company?
9. Hedging Decision. Kayla Co. imports products from India, and it will make payment in rupees in 90 days. Interest rate parity holds. The prevailing interest rate in India is very high, which reflects the high expected inflation there. Kayla expects that the Indian rupees will depreciate over the next 90 days. Yet, it plans to hedge its payables with a 90-day forward contract. Why may Kayla believe that it will pay a smaller amount of Australian dollars when hedging than if it remains unhedged?
10. Hedging Payables. Assume the following information:

90-day Australian interest rate = 4% 90-day Malaysian interest rate = 3%

90-day forward rate of Malaysian ringgit = A$0.400 Spot rate of Malaysian ringgit = A$0.404

Assume that Australia’s leading retailer, Harvey Norman, 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.

11. Hedging Decision on Receivables. Assume the following information: 180-day Australian interest rate = 8%

180-day British interest rate = 9%

180-day forward rate of British pound = A$1.50 Spot rate of British pound = A$1.48

Assume that Riverside Corp. from Australia will receive £400,000 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.

12. 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?
13. Currency Options. Can Brooklyn Co. determine whether currency options will be more or less expensive than a forward hedge when considering both hedging techniques to cover net payables in euros? Why or why not?
14. Hedging With Put Options. As treasurer of Tucson Corp. (a US exporter to New Zealand), you must decide how to hedge (if at all) future receivables of 250,000 New Zealand dollars 90 days from now. Put options are available for a premium of US$0.03 per unit and an exercise price of US$0.49 per New Zealand dollar. The forecasted spot rate of the NZ$ in 90 days follows:

 

Future Spot Rate	Probability
US$0.44	30%
US$0.40	50%
US$0.38	20%

 

Given that you hedge your position with options, create a probability distribution for US dollars to be received in 90 days.

 

15. Forward Hedge. Would Oregon Co.’s real cost of hedging Australian dollar payables every 90 days have been positive, negative, or about zero on average over a period in which the dollar weakened consistently? What does this imply about the forward rate as an unbiased predictor of the future spot rate? Explain.
16. Forward versus Options Hedge on Payables. If you are a US importer of Australian goods and you believe that today’s forward rate of the Australian dollar is a very accurate estimate of the future spot rate, do you think Australian dollar call options would be a more appropriate hedge than the forward hedge? Explain.
17. Forward versus Options Hedge on Receivables. You are an exporter of goods to Australia, and you believe that today’s forward rate of the Australian dollar substantially underestimates the future spot rate. Company policy requires you to hedge your Australia dollar receivables in some way. Would a forward hedge or a put option hedge be more appropriate? Explain.
18. Forward Hedging. Explain how a Malaysian company can use the forward market to hedge periodic purchases of Australian goods denominated in Australian dollars. Explain how a French firm can use forward contracts to hedge periodic sales of goods sold to Australia that are invoiced in Australian dollars. Explain how a British company can use the forward market to hedge periodic purchases of Japanese goods denominated in yen.
19. Hedging Payables with Currency Options. Malibu, Inc., is a US company that imports Australian goods. It plans to use call options to hedge payables of 100,000 Australian dollar in 90 days. Three call options are available that have an expiration date 90 days from now. Fill in the number of US dollars needed to pay for the payables (including the option premium paid) for each option available under each possible scenario.

 

Spot Rate	Spot Rate of Australian dollar 90 Days from now	Exercise Price = US$0.74 Premium = US$0.06	Exercise Price = US$0.76 Premium = US$0.05	Exercise Price = US$0.79 Premium = US$0.03
1	US$0.65
2	US$0.70
3	US$0.75
4	US$0.80
5	US$0.85

 

If each of the five scenarios had an equal probability of occurrence, which option would you choose? Explain.

20. Techniques for Hedging Receivables. SMU Corp. has future receivables of 4 million New Zealand dollars (NZ$) in one year. It must decide whether to use options or a money market hedge to hedge this position. Use any of the following information to make the decision. Verify your answer by determining the estimate (or probability distribution) of Australian dollar revenue to be received in one year for each type of hedge.

 

Spot rate of NZ$ = A$0.54

One-year call option: Exercise price = A$0.50; premium = A$0.07 One-year put option: Exercise price = A$0.52; premium = A$0.03

 

	Australia	New Zealand
One-year deposit rate	9%	6%
One-year borrowing rate	11%	8%
Forecasted spot rate of NZ$	Rate A$0.50	Probability 20%
	A$0.51	50
	A$0.53	30

 

21. Forecasting Cash Flows and Hedging Decision. Virginia Co. has a subsidiary in Hong Kong and in Thailand. Assume that the Hong Kong dollar is pegged at US$.13 per Hong Kong dollar and it will remain pegged. The Thai baht fluctuates against the US dollar, and is presently worth US$.03. Virginia Co. expects that during this year, the US inflation rate will be 2 per cent; the Thailand inflation rate will be 11 per cent, while the Hong Kong inflation rate will be 3 per cent. Virginia Co. expects that purchasing power parity will hold for any exchange rate that is not fixed (pegged). Virginia Co. will receive 10 million Thai baht and 10 million Hong Kong dollars at the end of one year from its subsidiaries.

 

1. Determine the expected amount of US dollars to be received from the Thai subsidiary in one year when the baht receivables are converted to US dollars.

 

2. The Hong Kong subsidiary will send HK$1 million to make a payment for supplies to the Thai subsidiary. Determine the expected amount of baht that will be received by the Thai subsidiary when the Hong Kong dollar receivables are converted to Thai baht.

 

3. Assume that interest rate parity exists. Also assume that the real one-year interest rate in the United States is 1.0%, while the real interest rate in Thailand is 3 per cent. Determine the expected amount of US dollars to be received by Virginia Co. if it uses a one-year forward contract today to hedge the receivables of 10 million baht that will arrive in one year.

 

22. Money Market Versus Put Option Hedge. Narto Co. (a US company) exports to Australia and expects to receive 500,000 Australian dollar in one year. The one-year US interest rate is 5 per cent when investing funds and 7 per cent when borrowing funds. The one-year Australian interest rate is 9 per cent when investing funds, and 11 per cent when borrowing funds. The spot rate of the Australian dollar is US$0.80. Narto expects that the spot rate of the Australian dollar will be US$0.75 in one year. There is a put option available on Australian dollar with an exercise price of US$0.79 and a premium of US$0.02.

 

1. Determine the amount of US dollars that Narto Co. will receive at the end of one year if it implements a money market hedge.

 

2. Determine the amount of US dollars that Narto Co. expects to receive at the end of one year (after accounting for the option premium) if it implements a put option hedge.

 

23. Comparison of Hedging Techniques. Today, the spot rate of the Australian dollar is US0.79. The one-year forward rate is A$0.75. A one-year call option on Australian dollar exists with a premium of US$0.04 per unit and an exercise price of US$0.76. You think the spot rate is the best forecast of future spot rates. You will need to pay 10 million Australian dollar in one year. Determine whether a money market hedge or a call option hedge would be more appropriate to hedge your payables. (Assume that the one-year interest rate in Australia and United States are 9 per cent and 4 per cent, respectively)

 

24. Estimating the Hedged Cost of Payables. Grady Co. is a manufacturer of hockey equipment in Chicago, and will need 3 million Australian dollar in one year to pay for imported supplies. The US one-year interest rate is 2 per cent while Australia’s one-year interest rate is 7 per cent. The spot rate of the Australian dollar is US$0.90. The one-year forward rate of the Australian dollar is US$0.88. A one-year call option on Australian dollar exists with an exercise price of US$0.90 and a premium of US$0.03 per unit. As the Treasurer of Grady Co., you think the spot rate of the Australian dollar is the best forecast of the future spot rate of the Australian dollar.

1. If you use a money market hedge, determine the amount of US dollars that you will pay for the payables.

 

2. If you use a call option hedge, determine the expected amount of US dollars that you will pay for the payables (account for the option premium within your estimate).