Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £1

Question

Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £15 million payable in one year (i.e., Boeing has a £15 million receivable in one-year). The money market rates, foreign exchange rates, and option prices are given as follows:

The U.S. one-year interest rate: 2.8% per annum The U.K. one-year interest rate: 2.5% per annum The spot exchange rate: $1.55/£

Show the money market hedge strategy (i.e., through borrowing/lending) that the company can use to hedge the company’s transaction exposure. Be sure to include the following.

(1) State which currency Boeing should borrow and which to invest.
(2) Calculate how much Boeing should borrow or invest.
(3) State the transactions needed to be done and the cash flows at t=0 and t=1

-->(i.e., today and one-year from today) by constructing a cash flow table with CF0 CF1 columns

show all work..thank you!

Explanation / Answer

Money Market Hedge

Step 1: Boeing borrows 15 million pounds in the U.K. at t=0

Borrowing amount is the discounted PV of the pounds receivable = £15million/(1.025)= £14,634,146.34

Step 2: Boeing converts £ into $ using spot exchange rate $1.55/£.

Dollar amount= (£14,634,146.34)($1.55/£)=$22,682,926.83

Step 3: Boeing invests $ in the U.S. at an interest rate of 2.8% for 1 year.

Step 4: Boeing collects £15 million receivables to repay the pound loan in step 1

Step 5: Boeing receives the maturity value of dollar investment in step 3

($22,682,926.83)(1+ 2.8%)= $23,318,048.78

Cash Flow Table:

Borrow Pounds

Buy Dollar Spot

Invest in US

Collect Pounds Receivables

Net Cash Flow

T=0 T=1

Borrow Pounds

£14634146.34 -£15,000,000.00

Buy Dollar Spot

$22,682,926.83 with Pounds -£14634146.34

Invest in US

-$22,682,926.83 $23,318,048.78

Collect Pounds Receivables

£15,000,000.00

Net Cash Flow

0 $23,318,048.78

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