Your firm is a Swiss importer of 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 pound denominated payable into a Swiss franc-denominated payable with a one-year maturity. The following were computed without rounding. Select the answer closest to yours.
A)SFr. 2,000,000
B)SFr. 2,151,118.62
C)SFr. 2,068,383.28
D)SFr. 1,921,941.75

Question

Your firm is a Swiss importer of 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 pound denominated payable into a Swiss franc-denominated payable with a one-year maturity.  The following were computed without rounding. Select the answer closest to yours.
A)SFr. 2,000,000 
B)SFr. 2,151,118.62 
C)SFr. 2,068,383.28 
D)SFr. 1,921,941.75

Quizplus · Accepted Answer

To redenominate the payable into Swiss francs, we need to sell £1,000,000 forward for Swiss francs. Based on current spot and forward rates, this can be done as follows:

Spot rate: £1 = SFr. 2.0500
1-year forward rate: £1 = SFr. 2.1217

We can thus sell £1,000,000 forward for:

SFr. 2.1217 x £1,000,000 = SFr. 2,121,700

We receive this Swiss franc amount in 12 months when the payment is due. To make sure we have enough Swiss francs to pay the supplier, we can invest this amount in a Swiss franc-denominated money market security for one year.

The present value of this investment, using the current Swiss franc interest rate, will be:

PV = SFr. 2,121,700 / (1 + 0.6%)^12 = SFr. 2,068,383.28

Therefore, the amount we need to pay the supplier in Swiss francs is SFr. 2,068,383.28.

Your Firm Is a Swiss Importer of Bicycles