FIN 3410 Lecture Notes - Lecture 10: European Route E20

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Day 10 Notes
EX CH8 4
Background
Hedging receivable
Receivable = E 20 mil
N = 1 year
So = $1.05/E
F1 = $1.10/E
I$ = 6%
IE = 5%
Boeing’s FX risk
o E depreciation against $
o $ value of E 20 mil down
A. 2 hedging alternatives:
a. FH forward sale of receivable (a short forward)
b. MMH Borrow E against receivable
i. E $
ii. Invest $ in the US
B. Which alternative is recommended? Why?
a. Receivable = E 20 mil
b. Concerned with $ proceeds ($ revenues) from E receivable
c. Recommend a hedging method with higher $ proceeds
i. FV(FH) = ?
ii. FV(MMH) = ?
A)
FV(FH)
Receivable = E 20 mil
Hedge with a short forward
Agree to sell E 20 mil in one year @ F1 = $1.10/E
FV(FH) = E 20 mil * $1.10/E = $ 22 mil
FV(MMH)
1. Borrow E against receivable
a. E loan = PV(receivable) = PV (E 20 mil)
b. E 20,000,000 / (1 + 0.05) = E 19,047,619
2. Exchange borrowed E for $
a. E 19,047,619 * ($1.05/E) = $20,000,000
3. Invest $20,000,000 in the US for 1 year @ I$ = 6%
a. FV(MMH) = ($investmenttoday) * (1+i$)
b. FV(MMH) = $20,000,000 * (1+ 0.06) = $21,200,000
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