Week 11 - Agenda

Hedging Techniques
InternationalCash Flow (Ch 21)
Appendix (Ch 14)
Practice Questions
Question
The exact cost of hedging with call
options is not known with certainty at the
time that the options are purchased.
a. True
b. False
Question
The price at which a currency put option
allows the holder to sell a currency is
called the exercise price.
a. True
b. False
Money Market Hedge on Payables
(100,000 Euros)
Forward Contract on Payables -
$120,000
Call Option - $122,200
Money Market Hedge on Payables
Itinvolves taking a money market
position to cover a future payable
position.
Money Market Hedge on Payables
 US-based MNC will needs 100,000 Euros in 1 year.
 It borrows & converts dollars to Euros and deposit Euros in
bank.
 Assume, it earns 5% on deposit, it would need to deposit:
= €100,000 / (1 + 0.05)
= € 95,238
 Assuming a spot rate of $1.18, dollars needed to make a
deposit:
= € 95,238 x $1.18
= $112,381
 Assume, it can borrow fund @ 8%, amount required to pay
loan:
= $112,381 x (1 + 0.08) = $121,371
Money Market Hedge on Payables
(100,000 Euros)
Forward Contract on Payables -
$120,000
Call Option - $122,200
Money Market Hedge - $121,371
Which technique is better?
Money Market Hedge on Receivables
(SF 200,000)
Forward Contract = $142,000
Put Option = $144,000
Money Market Hedge on Receivables
 US-based MNC will receive 200,000 Swiss Franc in 6-months.
 Assume, It can borrow funds in SF @ 3% for 6-months.
 The amount it should borrow so that it can use entire
receivable to pay entire loan in 6 months:
Amount to borrow = SF200,000 / (1 + 0.03)
= SF194,175
MNC can convert the amount into dollars e.g. SF 194,175 X $.70
= $135,922
It can invest the money at say 2% return i.e. $135,922 (1+0.02)=
$ 138,640
So its receivables would be equal to $138,640 in six months
Money Market Hedge on Receivables
(SF 200,000)
Forward Contract = $142,000
Put Option = $144,000
Money Market = $138,640
Which option is better?
Which of the following reflects a hedge of net
payables on British pounds by a U.S. firm?

A. purchase a currency put option in

British pounds.
B. sell pounds forward.
C. sell a currency call option in British
pounds.
D. borrow U.S. dollars, convert them to
pounds, and invest them in a British
pound deposit.
Answer D
Group Work – 20 Minutes
PracticeQuestions
Question from last week
Alternative Hedging Techniques
Leading and lagging

Subsidiary in UK If Forint is expected to go

up in value, the subsidiary
Paying in Hungry would expedite the
Forint payment
Alternative Hedging Techniques
Currency Diversification:-
The inflow will be stable if
currencies to be received are not
highly positively correlated.
Alternative Hedging Techniques
Cross Hedging
US firm needs to pay in Zloty in 90 days
Forward hedge is not available for Zloty,
which is expected to go up.
But Zloty ≈ Euro
US firm will buy forward contract in
Euros
Forward Vs Future Contracts
Future contracts are relatively
small in size.
Exchanges are involved.