Financial contracts(1):Forward Market HedgeYou are a U.S. importer of British woolens and havejust ordered next year's inventory. Payment of100Misdueinoneyear.Answer: you can hedge your f100 millionpayable by buying f100M in one year-along forward contract on the pound
You are a U.S. importer of British woolens and have just ordered next year’s inventory. Payment of £100M is due in one year. Financial contracts(1) : Forward Market Hedge Answer: you can hedge your £100 million payable by buying £100M in one year—a long forward contract on the pound
ForwardMarketHedgeIf you are going to owe foreign currency inthe future, agree to buy the foreigncurrency now by entering into long positionin a forward contract.If you are going to receiveforeigncurrency in the future, agree to sell theforeign currency now by entering into shortposition in a forward contract
Forward Market Hedge ❖If you are going to owe foreign currency in the future, agree to buy the foreign currency now by entering into long position in a forward contract. ❖If you are going to receive foreign currency in the future, agree to sell the foreign currency now by entering into short position in a forward contract
Financial contracts (2):MoneyMarket HedgeThe importer of British woolens canalso hedge his 100million payable with a money market hedge This is the same idea as covered interest arbitrage(borrow-spot-invest, BSl Method)Information:S($/E)$1.25/Spot exchange rateF360($/E)$1.20/360-dayforwardrateis7.10%U.S. discount rate=it11.56%British discountrate
Financial contracts (2): Money Market Hedge The importer of British woolens can also hedge his £100 million payable with a money market hedge ❖ This is the same idea as covered interest arbitrage (borrow-spot-invest, BSI Method) ❖ Information: Spot exchange rate S($/£) = $1.25/£ 360-day forward rate F360($/£) = $1.20/£ U.S. discount rate i$ = 7.10% British discount rate i£ = 11.56%
MoneyMarket Hedge1. Borrow $112.05 million in the U.S2. Translate $112.05 million into pounds at the spotrate S($/) = $1.25/f3. Invest f89.64 million in the UK at i = 11.56% forone year.In one year your investment will have grown to 100million.At the same time, you need to repay the bank:$112.05M (1*7.10%)=120.05M
Money Market Hedge 1. Borrow $112.05 million in the U.S. 2. Translate $112.05 million into pounds at the spot rate S($/£) = $1.25/£ 3. Invest £89.64 million in the UK at i£= 11.56% for one year. In one year your investment will have grown to £100 million. At the same time, you need to repay the bank: $112.05M (1*7.10%)=120.05M