Hw 3 Solutions 11. Assume the Following Information: 90‑Day U.S. Interest Rate = 4% 90‑Day Malaysian Interest Rate = 3% 90‑Day Forward Rate of Malaysian Ringgit = $.400 Spot Rate of Malaysian Ringgit = $.404 Assume That

HW 3 Solutions

11. Assume the following information:

90‑day U.S. interest rate = 4%

90‑day Malaysian interest rate = 3%

90‑day forward rate of Malaysian ringgit = $.400

Spot rate of Malaysian ringgit = $.404

Assume that the Santa Barbara Co. in the United States 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.

ANSWER: If the firm uses the forward hedge, it will pay out 300,000($.400) = $120,000 in 90 days. If the firm uses a money market hedge, it will invest (300,000/1.03) = 291,262 ringgit now in a Malaysian deposit that will accumulate to 300,000 ringgit in 90 days. This implies that the number of U.S. dollars to be borrowed now is (291,262 × $.404) = $117,670. If this amount is borrowed today, Santa Barbara will need $122,377 to repay the loan in 90 days (computed as $117,670 × 1.04 = $122,377). In comparison, the firm will pay out $120,000 in 90 days if it uses the forward hedge and $122,377 if it uses the money market hedge. Thus, it should use the forward hedge.

33. SMU Corp. has future receivables of 4,000,000 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 dollar revenue to be received in one year for each type of hedge.

Spot rate of NZ$ = $.54

One‑year call option: Exercise price = $.50; premium = $.07

One‑year put option: Exercise price = $.52; premium = $.03

U.S. New Zealand

One‑year deposit rate 9% 6%

One‑year...