Question

Question 3 BAF Limited is involved in international business. It has the following receivables and payables: Table A: Total receivables US$10 million Market Spot rate 1 month Forward rate 3 month forward rate Exchange rate GHC1.5/8 GHC1.4/$ GHC1.71$ Expected amount in GHC Х Y Z Table B: Total payables £20 million Market Spot rate 1 month Forward rate 3 month forward rate Exchange rate GHC1.5/£ GHC1.4 £ GHC1.71 £ Expected amount in GHC C D E a. Will BAF Limited hedge its receivables through leading or lagging strategy? b. Will BAF Limited hedge its payables through leading or lagging strategy? c. Indicate its cash flows for X. Y and Z. d. Indicate its cash flows for CD and E.

Answer 1

a) if considering 1 month forward rate option:

BAF limited shall lead the receipt as exchange rate at 1 month forward is declined as compared to Spot rate which gives the company lower amount after one month at a reduced exchange rate. Therefore it is suggested to lead the receipt.

lf considering 3 months forward rate option

will hedge it's receivables through lagging strategy as it appears from the chart that £ is getting stronger as the exchange rate for £ is increasing will result in increase in inflow at an increased exchange rate. It is suggested to lag the receipt after 3 months

b) if considering 1 month forward rate option

As one month forward rate is lower than spot rate BAF limited will get benefited by lagging the payment as it results in lower outflow of funds from the entity. Therefore it is suggested to lag the payment.

If 3 months forward rate option is considered

As mentioned earlier higher exchange rate results in higher cash flows. But the same is unfavorable in case of payables as it would result in excess payment of funds to the payee. Therefore, BAF Limited shall lead the payment as the exchange rate for £ is lower at spot rate when compared to forward rates. So the outflow of funds towards payables will less. Therefore it is advisable to lead the payment to payables.