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:
A) $0.
B) -$7,500.
C) $7,500.
D) None of these are correct.

Question

Quizplus · Accepted Answer

To calculate the revenue from hedging minus the revenue from not hedging receivables, we need to compare the two scenarios: hedging and not hedging.

In the hedging scenario, Money Corp. will lock in the MYR/USD exchange rate at the 30-day forward rate of $.23. Therefore, if the Malaysian ringgit depreciates to $.20, Money Corp. will still receive MYR1,500,000 x $.23 = $345,000, which is higher than what they would have received without hedging (MYR1,500,000 x $.20 = $300,000). However, if the Malaysian ringgit appreciates to $.25, Money Corp. will still only receive MYR1,500,000 x $.23 = $345,000, which is lower than what they would have received without hedging (MYR1,500,000 x $.25 = $375,000). Therefore, the revenue from hedging in this scenario is $45,000 ($345,000 - $300,000).

In the not hedging scenario, Money Corp. will receive whatever amount the MYR/USD exchange rate is at the end of the month. Therefore, if the Malaysian ringgit depreciates to $.20, Money Corp. will receive MYR1,500,000 x $.20 = $300,000. However, if the Malaysian ringgit appreciates to $.25, Money Corp. will receive MYR1,500,000 x $.25 = $375,000. Therefore, the revenue from not hedging in this scenario is $375,000 - $300,000 = $75,000.

Finally, to calculate the revenue from hedging minus the revenue from not hedging receivables, we subtract the revenue from not hedging from the revenue from hedging: $45,000 - $75,000 = -$30,000. However, since the question asks for the absolute value of the difference, the answer is $30,000. Therefore, the best choice is C.