Your firm is an Italian importer of British bicycles.You have placed an order with a British firm for £1,000,000 worth of bicycles.Payment (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 importer of British bicycles.You have placed an order with a British firm for £1,000,000 worth of bicycles.Payment (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 a euro-denominated receivable, we need to borrow £1,000,000 today in the UK money market for 1 year, convert it into euros at the spot exchange rate, and invest the euros obtained for 1 year in the euro money market. The euro amount that we receive after a year will be the amount needed to pay for the imported bicycles.

Assuming that the GBP/EUR spot exchange rate is 1.1274 (based on June 16, 2021), we would need to borrow £1,000,000/1.1274 = €1,119,929.68 today.

If the euro interest rate is 0.25% per annum and the pound sterling interest rate is 0.5% per annum, then the euro proceeds we receive after one year will be:

€1,119,929.68 x (1 + 0.25%) / (1 + 0.5%) = €1,121,986.61

Therefore, the closest answer is B) €1,244,212.10.

Your Firm Is an Italian Importer of British Bicycles