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Money Market Instruments

International Finance

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30 views1 page

Money Market Instruments

International Finance

Uploaded by

muhammad atif
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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206 PA RT T H R E E FOREIGN EXCHANGE EXPOSURE AND MANAGEMENT

EXHIBIT 8.7 Boeing’s Alternative Hedging Strategies: A Summary


Strategy Transactions Outcomes
Forward market hedge 1. Sell £10,000,000 forward for U.S Assured of receiving $14,600,000
dollars now. in one year; future spot exchange
2. In one year, receive £10,000,000 rate becomes irrelevant.
from the British client and deliver
it to the counterparty of the
forward contract.
Money market hedge 1. Borrow £9,174,312 and buy Assured of receiving $13,761,468
$13,761,468 spot now. now or $14,600,918 in one year;
2. In one year, collect £10,000,000 future spot exchange rate becomes
from the British client and pay off irrelevant.
the pound loan using the amount.
Options market hedge 1. Buy a put option on £10,000,000 Assured of receiving at least
for an upfront cost of $200,000. $14,387,800 or more if the future
2. In one year, decide whether to spot exchange rate exceeds the
exercise the option upon observing exercise exchange rate; Boeing
the prevailing spot exchange rate. controls the downside risk while
retaining the upside potential.

We examine alternative ways of hedging this foreign currency payable using (i) for-
ward contracts, (ii) money market instruments, and (iii) currency options contracts.
Facing an account payable, Boeing will have to try to minimize the dollar cost of pay-
ing off the payable.

Forward Contracts If Boeing decides to hedge this payable exposure using a forward contract, it only
needs to buy £5 million forward in exchange for the following dollar amount:
$8,750,000 5 (£5,000,000) ($1.75/£).
On the maturity date of the forward contract, Boeing will receive £5,000,000 from the
counter-party of the contract in exchange for $8,750,000. Boeing then can use £5,000,000
to make payment to Rolls-Royce. Since Boeing will have £5,000,000 for sure in exchange
for a given dollar amount, that is, $8,750,000, regardless of the spot exchange rate that
may prevail in one year, Boeing’s foreign currency payable is fully hedged.

Money Market Instruments If Boeing first computes the present value of its foreign currency payable, that is
£4,694,836 5 £5,000,000/1.065,
and immediately invests exactly the same pound amount at the British interest rate of
6.5 percent per annum, it is assured of having £5,000,000 in one year. Boeing then
can use the maturity value of this investment to pay off its pound payable. Under this
money market hedging, Boeing has to outlay a certain dollar amount today in order to
buy spot the pound amount that needs to be invested:
$8,450,705 5 (£4,694,836) ($1.80/£).
The future value of this dollar cost of buying the necessary pound amount is computed
as follows:
$8,957,747 5 ($8,450,705) (1.06),
which exceeds the dollar cost of securing £5,000,000 under forward hedging,
$8,750,000. Since Boeing will have to try to minimize the dollar cost of securing the
pound amount, forward hedge would be preferable to money market hedge.

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