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.

Contract Size Country U.S. $ equiv. Currency per U.S. $ interest rates APR

£ 10,000 Britain (pound) 1.9600 £ 0.5102

12 months forward 2.0000 £ 0.5000

€ 10,000 Euro 1.5600 € 0.6410 ⁱ$ = 1%

12 months forward 1.6000 € 0.6250 ⁱ€ = 2%

SFr. 10,000 Swiss franc 0.9200 SFr. 1.0870 ⁱ£ = 3%

12 months forward 1.0000 SFr. 1.0000 ⁱSFr. = 4 4%

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.

Contract Size	Country	U.S. $ equiv.	Currency per U.S. $	interest rates	APR
£ 10,000	Britain (pound)	1.9600	£ 0.5102
	12 months forward	2.0000	£ 0.5000
€ 10,000	Euro	1.5600	€ 0.6410	ⁱ$ =	1%
	12 months forward	1.6000	€ 0.6250	ⁱ€ =	2%
SFr. 10,000	Swiss franc	0.9200	SFr. 1.0870	ⁱ£ =	3%
	12 months forward	1.0000	SFr. 1.0000	ⁱSFr. = 4	4%

The following were computed without rounding.Select the answer closest to yours.

Quizplus · Accepted Answer

To use a money market hedge, the company needs to borrow £1,000,000 in the UK for one year and convert it into euros at today's spot rate. The company would then invest the euros at the one-year euro deposit rate. At the end of the year, the company would convert the euro investment back into pounds at the one-year forward rate, which eliminates the foreign exchange risk. 
Assuming the spot rate is £1 = €1.2 and the one-year euro deposit rate is 2%, the company would need to borrow £833,333.33 to convert to €1,000,000. 
After one year, the company would receive the euro investment plus interest, which would be €1,020,000. Converting this amount back into pounds at the one-year forward rate of £1 = €1.2/1.02 = £1.1765 yields £1,199,999.97, which is very close to the original receivable amount of £1,000,000. 
Therefore, the closest answer is B) €1,244,212.10.

Your Firm Is an Italian Exporter of Bicycles