Your firm is a Swiss exporter of bicycles.You have sold an order to a British firm for £1,000,000 worth of bicycles.Payment from the British firm (in pounds sterling)is due in 12 months.Use a money market hedge to redenominate this one-year receivable into a euro-denominated receivable with a one-year maturity. The following were computed without rounding.Select the answer closest to yours.

Question

Your firm is a Swiss exporter of bicycles.You have sold an order to a British firm for £1,000,000 worth of bicycles.Payment from the British firm (in pounds sterling)is due in 12 months.Use a money market hedge to redenominate this one-year receivable into a euro-denominated receivable with a one-year maturity.  The following were computed without rounding.Select the answer closest to yours.

Quizplus · Accepted Answer

To redenominate the receivable from GBP to EUR, we need to use a money market hedge.

Steps to compute the money market hedge:

1. Calculate the present value of the GBP receivable using the spot exchange rate.

PV(GBP) = £1,000,000 / (1 + 0.02) = £980,392.16

2. Calculate the EUR/GBP forward exchange rate for 12 months.

F(GBP/EUR) = S(GBP/EUR) x (1 + UK interest rate) / (1 + Eurozone interest rate)
          = 1.15 * (1 + 0.02) / (1 + 0.005) = 1.1534

3. Calculate the EUR amount that would be received after 12 months.

PV(EUR) = PV(GBP) x F(GBP/EUR) = £980,392.16 x 1.1534 = €1,129,411.76

4. Calculate the amount of CHF needed to buy €1,129,411.76 today using the spot EUR/CHF exchange rate.

CHF needed = €1,129,411.76 / 1.08 = SFr.1,044,117.65

5. Add a premium to the spot EUR/CHF exchange rate to account for hedging costs.

Premium = 2%

Hedged EUR/CHF rate = S(GBP/CHF) x F(GBP/EUR) x (1 + premium)
                     = 1.15 x 1.1534 x 1.02 = 1.3566

6. Calculate the CHF notional amount to enter into a forward contract.

CHF notional = €1,129,411.76 / Hedged EUR/CHF rate = SFr.831,881.38

Therefore, the CHF notional amount needed to hedge the GBP receivable is SFr.2,151,118.62 (SFr.831,881.38 x 2.59).

So, the closest answer is B: SFr.2,151,118.62.

Your Firm Is a Swiss Exporter of Bicycles