Lesson_53_Hedging

# Lesson_53_Hedging - Hedging Because exchange rates change...

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1 Lesson 53 1 Hedging Because exchange rates change frequently, anyone who owes foreign currency in the future, or who will receive currency in the future is susceptible to risk How can this risk be eliminated? Lesson 53 2 Examples: Spot exchange rate is currently \$0.90 per euro An importer of German steel has to pay €1 million in 30 days If rate unchanged, the importer will have to pay \$900,000 But what if euro appreciates? Depreciates? Lesson 53 3 Examples: An exporter of computers to Mexico is willing to accept payment in pesos, but payment will not be made for 60 days How many dollars will a given number of pesos be worth in 60 days?

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2 Lesson 53 4 Consider first example Need €1 million in 30 days Make this choice more attractive by depositing in interest-bearing account One possibility: buy euro today at known rate, hold onto them for 30 days Lesson 53 5 Suppose a euro account would pay 0.5% interest (0.005) at the end of 30 days How many euros needed today to end with 1 million in 30 days? 1,000,000 995,025 1.005 = Lesson 53 6 To see this, let D be the size of deposit today Let i represent the interest rate (expressed in decimal form) over relevant time horizon ( ) 1 Di + Amount at end of period:
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## This note was uploaded on 09/14/2009 for the course ECON 340 taught by Professor Leidholm during the Summer '08 term at Michigan State University.

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Lesson_53_Hedging - Hedging Because exchange rates change...

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