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, we need to borrow pounds sterling (GBP) today, exchange them for euros (EUR) and invest the euros for 12 months, which will mature exactly when the receivable becomes due. The proceeds from the investment will redeem the loan, and the remaining euros will be the euro-denominated receivable. 
The steps involve in computing the amount of euros needed:
1. Calculate the GBP amount of the receivable in 1 year: £1,000,000
2. Compute the 1-year forward rate GBP/EUR: Assume the rate is 1.2442 (meaning 1 GBP equals 1.2442 EUR in 1 year)
3. Compute the EUR amount of the receivable: £1,000,000/1.2442 = €1,244,212.10

Therefore, the closest answer to the computed EUR amount is B) €1,244,212.10.

Your Firm Is an Italian Exporter of Bicycles