Question

You are an American real estate mogul. You have just purchased a chain of boutique hotels in the Swiss Alps for CHF 35,000,000. You have financed the purchase with a loan from a Swiss bank in CHF. How can you hedge your currency risk? Describe the hedge and the cashflows in detail. Assume that all payments are annual, and the current exchange rate is CHF 1/USD.

Answer 1

Answer:

Since the investor is from the US and purchases a hotel in Swiss Alps for CHF 35,000,000, the investor will have to pay interest in the currency CHF.

In order to hedge the currency risk the investor can go for SWAPS where he will recieve the interest in CHF and pay in USD.

Cash flow:

Notional amount = $35,000,000

exchange rate = CHF 1 / USD

Bid price is 5.25% for CHF hence when an investor goes into swap contract then he will get 5.25%. Similarly for USD when investor pays in USD then he will have to pay the ask rate of 8.85%.

The investor will pay 8.85% interest rate in USD and get the 5.25% interest rate in CHF. This interest can be used to pay the interest on loan