Question

Your firm is a U.K.-based importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a pound-denominated receivable with a one-year maturity.
Contract Size Country U.S. $ equiv. Currency per U.S. $
£ 10,000 Britain (pound) $ 1.9600 £ 0.5102 interest APR
12 months forward $ 2.0000 £ 0.5000 rates
€ 10,000 Euro $ 1.5600 € 0.6410 i$ = 1 %
12 months forward $ 1.6000 € 0.6250 i€ = 2 %
SFr. 10,000 Swiss franc $ 0.9200 SFr. 1.0870 i£ = 3 %
12 months forward $ 1.0000 SFr. 1.0000 iSFr. = 4 % The following were computed without rounding. Select the answer closest to yours.
A. £803,721.49
B. €800,000
C. £780,312.13
D. £72,352.94

Answer 1

Answer:

( A) £803,721.49

Explanation

==> Present value of €1,000,000 = 1000000/1.02 = €980,392.16

===> Converting Euro into US Dollar using spot exchange rate

€980,392.16×1.56 = $1,529,411.77

===>Converting US Dollar into Pounds using spot exchange rate

$1,529,411.77/1.96 = £780,312.13

===> investing this amount in UK

==>the amount of €1,000,000 is collected from French firm and it is used to repay the Euro loan

Step – 5 maturity value of pounds investment is received

£780,312.13 × 1.03 = £803,721.49

Therefore the answer is £803,721.49