Question

6) Suppose your U.S. firm will receive EUR1,000,000 in one year. The interest rate on the euro is 5% pa and on the U.S. dollar is 3% pa. The current spot rate for the euro is $1.00. If you use a money market hedge, how much will you receive in one year? Note: 1,000,000/1.03 = 970,874; 1,000,000/1.05 =952,381; 970874 1.05 = 1.019,418; 952,381 * 1.03 = 980,952. A) S980,952 B) 5970,874 $1,019,418 D) None of the above.

Answer 1

Under money market hedge, following will be undertaken:

Receivables = Euro 1,000,000

Borrow in Euro such amount that amount with interest reaches the amount receivable after one year = 1000,000/(1.05) = Euro 952,381

Convert into USD at spot rate and get 952,381*1 = USD 952,381

Invest in USD and get after one year = 952,381*1.03 = USD 980,952

Amount receivable in euro will be used to pay off loan

Hence, the answer is A)