Uk 3 month borrowing rate is 100 pa uk 3 month

  • No School
  • AA 1
  • 109

This preview shows page 82 - 88 out of 109 pages.

UK 3 month borrowing rate is 10.0% p.a. UK 3 month investing rate is 8.0% p.a. US 3 month borrowing rate is 8.0% p.a. US 3 month investing rate is 6.0% p.a. June put option in OTC market for £1,000,000; strike price $1.75/£; priced at $0.0265/£ Trident’s foreign exchange advisory service forecasts future spot rate in 3 months to be $1.7600/£ The budget rate (lowest acceptable amount) is based on an exchange rate of $1.7000/£
Image of page 82
Trident’s Transaction Exposure Trident faces four possibilities: Remain unhedged Hedge in the forward market Hedge in the money market Hedge in the futures market Hedge in the options market
Image of page 83
Trident’s Transaction Exposure Unhedged position If the future spot rate is $1.76/£, then Trident will receive £1,000,000 x $1.76/£ = $1,760,000 in 3 months However, if the future spot rate is $1.65/£, Trident will receive only $1,650,000 well below the budget rate
Image of page 84
Trident’s Transaction Exposure Forward Market hedge A forward hedge involves a forward contract The forward contract is entered at the time the A/R is created, in this case in March When this sale is booked, it is recorded at the spot rate. In this case the A/R is recorded at a spot rate of $1.7640/£, thus $1,764,000 is recorded as a sale for Trident If the firm wants to cover this exposure with a forward contract, then the firm will sell £1,000,000 forward today at the $1.7540/£ In 3 months, Trident will received £1,000,000 and exchange those pounds at $1.7540/£ receiving $1,754,000 This sum is $6,000 less than the uncertain $1,760,000 expected from the unhedged position This would be recorded in Trident’s books as a foreign exchange loss of $10,000 ($1,764,000 as booked, $1,754,000 as settled)
Image of page 85
Trident’s Transaction Exposure Money Market hedge To hedge in the money market, Trident will borrow pounds in London, convert the pounds to dollars and repay the pound loan with the proceeds from the sale To calculate how much to borrow, Trident needs to discount the PV of the £1,000,000 to today £1,000,000/1.025 = £975,610 Trident should borrow £975,610 today and in 3 months repay this amount plus £24,390 in interest (£1,000,000) from the proceeds of the sale Trident would exchange the £975,610 at the spot rate of $1.7640/£ and receive $1,720,976 at once (today) This hedge creates a pound denominated liability that is offset with a pound denominated asset thus creating a balance sheet hedge
Image of page 86
Trident’s Transaction Exposure In order to compare the forward hedge with the money market hedge, we must analyze the use of the loan proceeds Remember that the loan proceeds may be used today, but the funds for the forward contract may not Because the funds are relatively certain, comparison is possible in order to make a decision (the comparison is made on future values) Three logical choices exist for an assumed investment rate for the next 3 months First, if Trident is cash rich the loan proceeds might be invested at the US rate of 6.0% p.a.
Image of page 87
Image of page 88

You've reached the end of your free preview.

Want to read all 109 pages?

  • Fall '19
  • Trident

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask You can ask ( soon) You can ask (will expire )
Answers in as fast as 15 minutes