Lakewood Products, Inc. just bought €2,650,000 in products from a French supplier with payment due in 30 days. The spot exchange rate today is $1.2300/€ and the 30-day forward rate is $1.2310/€, but Lakewood is apprehensive that the dollar might fall even more during the 30-day period. The company has decided to use a money market hedge for this transaction. The French interest rate is 4.42 percent per annum or 0.3684 percent per month, and the U.S. interest rate is 5.40 percent per annum or 0.45 percent per month. How many dollars must Lakewood invest today to hedge this transaction with a money market hedge?

Question

Quizplus · Accepted Answer

To hedge using a money market hedge, Lakewood needs to invest the present value of the euro payment in dollars today. The present value of €2,650,000 at the French interest rate is €2,650,000 / (1 + 0.003684) = €2,640,272. The dollar amount needed today is €2,640,272 * $1.2300/€ = $3,247,536.