You (An American firm) expect to pay 100,000 Euros in one year to a European fir

Question

You (An American firm) expect to pay 100,000 Euros in one year to a European firm and you plan. to use the Money market hedge to hedge the FX risk: Then cornpare the results with a forward market hedge and pick the best choice for you: USA interest rate 1% Europe rate is 0% spot rate is S1.5/Euro and the forward rate is $1.70/Euro. Use this data to answer three quests To set up the money market hedge. you will borrow in and invest in a)USA: Europe b) Europe: USA 2)Using the money market hedge. hem many dollars will you need in one year to cover this payment a)$ 145,088 b)$152.145 c)$168,346 d)$147,247 3)Compare the results of the money market hedge with that of the Forward market hedge. Which will for pick a) Money market hedge b) Forward market gedge

Explanation / Answer

1 to set up the money market hedge you will borrow in us dollars and invest in euros 2 calculation of us dollar payable in money market hedge euros payable 100000 interest in europe 9% amount to invest in euros today to mature the amount to 100000 in one year 100000 / 1.09 amount to invest in euros today to mature the amount to 100000 in one year 91743.11927 exchange rate 1.5 us dollars on conversion 91743.12 * 1.50 us dollars on conversion 137614.68 interest rate in usa 7% interest amount for the amount borrowed 137614.70 * 7 % interest amount for the amount borrowed 9633.029 total us dollars payable 137614.70 + 9633.029 total us dollars payable $147,247 answer d $147,247 3 calculation of the forward exchange rate euros payable 100000 forward exchange rate 1.7 us dollars payable on forward contract 100000 * 1.70 us dollars payable on forward contract $170,000 comparing the amounts payable in money market hedge needs $ 1,47,247 and forward contract needs $ 1,70,000 hence as payment is less in money market , money market hedge have to be chosen

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