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a) A UK firm plans to use a money market hedge to hedge its payment of 3,000,000 Singapore dollars for Singapore goods in one year
a) A UK firm plans to use a money market hedge to hedge its payment of 3,000,000 Singapore dollars for Singapore goods in one year. The UK interest rate is 7%, while the Singapore interest rate is 12%. The spot rate of the Singapore dollar is £0.45, while the one-year forward rate is £0.44. Determine the amount of British pounds needed in one year if a money market hedge is used. (3 Marks)
b. Using the information in (a) above, would the Uk firm be better off hedging the payables with a money market hedge or with a forward hedge?
Expert Solution
a) As per money market hedge,
Forward Rate = Spot Rate * [(1+interest rate in UK)/(1+ interest rate in Singapore)]
= 0.45 * [(1+0.07)/(1+0.12)]
= 0.4299
Amount of British pounds to be paid in 1 year = 3,00,000 * 0.4710 = 1,28,970
b) The British firm would be better off using a money market hedge as in case of a forward hedge the British pounds to be paid in 1 year = 0.44* 3,00,000 = 1,32,000
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