Question 30 (Bonus 5): Assume that your company expects to receive a GBP 2,000,0

Question

Question 30 (Bonus 5): Assume that your company expects to receive a GBP 2,000,000 payment one year from now. The one-year actual forward rate of the USD/GBP is FD the synthetic one-year forward is SD/GBP 1.46. Which of the following statements is co Statement A: You can hedge this natural short position in GBP by entering a one-year long forward GBP contract. tatement B: Given the information above you should hedge your position with a money market hedge instead of an actual one-year short forward GBP contract a) Only Statement A is correct b) Only Statement B is correct c) Both statements are correct d) Both statements are wrong

Explanation / Answer

The answer is (b): Only statement B is correct.

This is because the syntheic forward rate is higher than the actual forward rate. A syntheyic forward rate is arrived at by creating off setting positions, that is enter agreement to buy and sell the same currency at the same expiration date. In the given case, the company has a receivable of 2 million GBP. If it enters into a forward agreement, it will be able to earn 1.42 $/GBP. However if the company enters a money market hedge and creates an offsetting position by borrowing GBP and repaying the loan by the receivable, it can earn $1.46 /GBP.

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