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Wamu Ltd a subsidiary of U.S multinational has a translation exposure of Kshs 20 Million. The...

Wamu Ltd a subsidiary of U.S multinational has a translation exposure of Kshs 20 Million. The rates are as follows;

Spot Shs 124.0/ £

One year forward shs 128.0/ £

A 6% depreciation of shilling is expected. How can the exchange risk be hedged

Wamu Ltd a subsidiary of U.S multinational has a translation exposure of Kshs 20 Million. The rates are as follows;

Spot Shs 124.0/ £

One year forward shs 128.0/ £

A 6% depreciation of shilling is expected. How can the exchange risk be hedged

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Answer #1

Ways to hedge Translation exposure:

1. Currency Swaps

2. Currency Options

3. Forward contracts

In this particular question we will be hedging the risk with the help of forward contracts.

Translation exposure amount- 20 million kshs

Forward rate- 128.0/pound

We will enter into a forward contract agreement to sell the 20 million kshs at shs 128.0/pound

=> 20 million / 128 = 156250 pounds

With the help of forward contract we have now binded the agreement at this amount. Now no matter whatever the spot rate at that time is, our amount will stand firm at 156250 pounds.

The risk has been hedged.

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