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Suggested Solution to HW 4
Slide 47 of Lecture 8
:
To use the money market to hedge her €100,000 shoe sale receivable in one year, the American
exporter can do the following:
Step 1: Borrow the present value of €100,000 for one year, that is, €100,000/(1+5%)=€95,238.10
today (i.e., t=0).
Step 2: Exchange €95,238.10 for $119,047.62 (=€95,238.10×$1.25/€1.00) at the prevailing spot
rate of $1.25/€1.00.
What is going to happen afterwards?
She invest the $119,047.62 proceeds on the U.S. $-denominated debt for one year,
earning 7.10% interest;
At maturity (i.e., t=1), she will owe €100,000 which can be paid off with her receivable;
At maturity (i.e., t=1), she will collect $127,500.00 from her $ investment;
She will have no exposure to the dollar-euro exchange rate.
Problem 8.4
:
(a) In the case of forward hedge, the future dollar proceeds will be (20,000,000)(1.10) =
$22,000,000.
In the case of money market hedge (MMH), the firm has to first borrow the PV of