Your firm is a U.K.-based importer of bicycles.You have placed an order with a Swiss firm for SFr.1,000,000 worth of bicycles.Payment (in Swiss francs)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 U.K.-based importer of bicycles.You have placed an order with a Swiss firm for SFr.1,000,000 worth of bicycles.Payment (in Swiss francs)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 euro, we need to borrow Swiss francs now (at the spot rate) and invest it in euros for one year (at the one-year forward rate). This will give us the euro equivalent of the receivable after one year, which we can then use to repay the Swiss franc loan.
Calculation:
1. Borrow Swiss Francs:
Borrowed amount = SFr.1,000,000
Spot rate = 1 SFr./£0.6280 = £1,588,153.42
Amount borrowed in GBP = SFr.1,000,000 x £1,588,153.42/SFr.1,000,000 = £1,588,153.42
2. Invest in Euros:
One-year forward rate = 1 SFr./€0.9095
Amount invested in Euros = £1,588,153.42/€0.9095 = €1,744,310.48
3. Repay Swiss Francs:
After one year, the receivable amount is still SFr.1,000,000
Repayment in GBP = SFr.1,000,000 x £0.6927/SFr.1 = £692,700.69
Profit = €1,744,310.48 - £692,700.69 = €1,051,609.79
Euro proceeds in GBP = €1,051,609.79/€0.9095 = £1,155,527.20
Net profit in GBP = £1,155,527.20 - £1,588,153.42 = -£432,626.22
Therefore, the best choice is B) £464,874.41, as it is the answer closest to our calculated net profit in GBP (-£432,626.22 rounded to the nearest penny).

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