Suppose it is 1987 and General Motors uses a money market hedge to protect a Lit 200 million payable due in one year. The U.S. interest rate at the time of the hedge was 9% and the lira interest rate was 14%. If the spot rate moved from Lit 1293 at the start of the year to Lit 1349 at the end of the year, what was GM's cost of the money market hedge?

Question

Quizplus · Accepted Answer

To calculate the cost of the money market hedge, we need to calculate how much GM would have paid if they had not hedged and then compare it to the cost of the hedge.

If GM had not hedged, they would have had to pay:

Lit 200,000,000 / 1293 = $154,607.51

Since GM hedged, they would have had to pay the interest rate differential between the US and Italy:

Lit 200,000,000 * (14% - 9%) = Lit 100,000,000

Converting Lit 100,000,000 to US dollars:

Lit 100,000,000 / 1349 = $74,158.21

Therefore, the cost of the money market hedge was:

$154,607.51 - $74,158.21 = $80,449.30

So the answer is B, $414.

Suppose It Is 1987 and General Motors Uses a Money