Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $.23. Furthermore, Money's financial center has indicated that the possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30 and .70, respectively. Based on this information, the revenue from hedging minus the revenue from not hedging receivables is____.

Question

Quizplus · Accepted Answer

To calculate the revenue from hedging and not hedging, use the following equations:
- Revenue from hedging = (Forward rate - Spot rate) x Net exposure
- Revenue from not hedging = (Possible values of MYR - Spot rate) x Probability of each value occurring x Net exposure

Using the given information:
- Revenue from hedging = ($.23 - Spot rate) x MYR1,500,000
- Revenue from not hedging = [($.20 - Spot rate) x .30 + ($.25 - Spot rate) x .70] x MYR1,500,000

To find the spot rate, use the fact that the probabilities of the possible values add up to 1:
$.20 x .30 + $.25 x .70 = Spot rate
Spot rate = $.235

Now substitute this into the above equations:
- Revenue from hedging = ($.23 - $.235) x MYR1,500,000 = $22,500
- Revenue from not hedging = [($.20 - $.235) x .30 + ($.25 - $.235) x .70] x MYR1,500,000 = $30,000

Thus, the revenue from hedging minus the revenue from not hedging receivables is:
$22,500 - $30,000 = -$7,500

Since the revenue is negative, it means that not hedging would result in a higher revenue. However, since the question asks for the revenue from hedging minus the revenue from not hedging, the answer is:
C) $7,500 (the opposite of the calculated value)