Page 167 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes For receivables:
1. Borrow in the foreign currency
2. Invest in the home currency (optional)
Suppose that on January 1, GE is awarded a contract to supply turbine blades to Lufthansa, the
German airline. On December 31, GE will receive payment of DM 25 million for this contract.
Further, suppose that DM and US $ interest rates are 15% and 10% respectively. Using a money
market hedge, GE will borrow DM 25/1.15 million = DM 21.74 million for one year, convert it
into $8.7 million in the spot market (spot exchange rate is DM 1 = $0.40) and invest them for one
year. On December 31, GE will receive 1.10 × $8.7 million = $9.57 million from its dollar
investment. GE will use these dollars to pay back the 1.15 × DM 21.74 million=DM 25 million it
owes in interest and principal.
Problem 1:
Assume that a MNC has net receivables of 100,000 Canadian dollars in 90 days. The spot rate of
the C$ is $.60, and the Canada interest rate is 2% over 90 days. Suggest how the MNC could
implement a money market hedge.

Solution:
The appropriate technique to achieve a covered money market hedge is:
1. Borrow an amount of Canadian Dollars such that the future receivables can be used to
repay the loan
100000
C$ =
1.02
+
= 98,039.22
2. Sell Canadian Dollars and buy USD at the spot rate

98,039.22 × .60 = $58823.532
3. Invest the proceeds in the US for 90 days at 12% pa.
C$ = $58823.532 × (1 + .03)
= $60588.237
Problem 2:

Assume that the same MNC now has net payable of 350,000 Mexican pesos in 180 days. The
Mexican interest rate is 8% over 180 days, and the spot rate of the Mexican peso is $.15. Suggest
how the U.S. firm could implement a money market hedge.
Solution:
Deposit = 350000/1.08 = Mexican pesos 324074.07 into a Mexican bank so that it amounts to
350000 MXP in 180 days.
To deposit 324074.07 MXP, the MNC has to borrow 324074.07 × .15 = USD 48611.11

Forward Market Hedge

In a Forward Market Hedge, a company that is long in a foreign currency will sell the foreign
currency forward, whereas a company that is short in a foreign currency will buy the currency
forward. In this way, the company can fix the dollar value of future foreign currency cash flow.

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