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 euros, we need to sell the Swiss francs at spot rate and invest the proceeds in a euro deposit for 12 months. 
1. Compute the forward rate for the CHF/EUR exchange rate in 1 year based on current spot rate and interest rates: 
Forward rate = (Spot rate x (1 + Interest rate in Europe)) / (1 + Interest rate in Switzerland)
Assuming spot rate is 1 CHF = 0.90 EUR; interest rate in Europe is 1% and interest rate in Switzerland is -0.5%:
Forward rate = (0.9 x 1.01) / (1 - 0.005) = 0.9095438 CHF/EUR

2. Calculate how much euros we would receive in 1 year from selling SFr. 1,000,000 at the spot rate:
1,000,000 / 0.9 = €1,111,111.11

3. Calculate how much we need to invest in euros today to have €1,111,111.11 in 1 year:
€1,111,111.11 / 1.01 = €1,099,999.97

4. Calculate how much we need to sell the SFr. 1,000,000 for in pounds at the spot rate:
1,000,000 / 0.9 = £888,888.89

5. Calculate how much we need to invest in pounds today to have £888,888.89 in 1 year: 
£888,888.89 / (1 + interest rate in the UK) = £464,874.41

Therefore, the closest answer is B: £464,874.41.

Your Firm Is a U