Your firm is an Italian exporter of bicycles.You have sold an order to a British firm for £1,000,000 worth of bicycles.Payment from the customer (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 an Italian exporter of bicycles.You have sold an order to a British firm for £1,000,000 worth of bicycles.Payment from the customer (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 into euros, we need to sell sterling and buy euros at the current exchange rate.

The formula for computing the euro amount is:

Euro amount = Pound amount x (1+ euro interest rate)/(1+ sterling interest rate)

Assuming the current exchange rate is £1 = €1.12, and euro interest rate is 0.5% and sterling interest rate is 1%, we can compute the euro amount as follows:

Euro amount = £1,000,000 x (1+0.005)/(1+0.01) x €1.12 = €1,244,212.10

Therefore, the best choice is B.

Your Firm Is an Italian Exporter of Bicycles