1993, Ford simultaneously borrows Spanish pesetas at 13% and invests dollars at 10%, both for one year. At the time Ford enters into these transactions, the spot rate for the peseta is $0.09If the spot rate is peseta 1 = $0.087 in one year, what is the cost to Ford of this money market hedge?
A) 2.0%
B) 3.8%
C) 1.3%
D) Ford has a 6.5% gain, not a cost

Question

Quizplus · Accepted Answer

The spot rate is peseta 1 = $0.087 in one year, which is higher than the spot rate of $0.09 when Ford entered into the transactions. This means that the peseta has appreciated against the dollar, and Ford will have to pay more pesetas to repay the loan. The cost of the hedge is the difference between the amount Ford borrowed and the amount it will have to repay, which is (13% - 10%) * $0.09 * 1 year = 2.7%. However, Ford also earns a gain on the dollar investment, which is (10% * $0.09 * 1 year) = 0.9%. Therefore, the net cost of the hedge is 2.7% - 0.9% = 1.8%, which is closest to choice D.

1993, Ford Simultaneously Borrows Spanish Pesetas at 13% and Invests