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Hi John
in the JUNE 11paper for the Q2 and part(b), the examiner said that ‘amount expected from US dollar receipts is 14681054, assuming that forward contract used’. I want to know whether it could use the money market hedge to get the deposit number?
(1) borrow $ now for four month: 20/(1+2.2%/3)=$19.85
(2) convert at the sport rate: 19.85/1.3618=14.58 Eur
(3) deposit the Euro for four month: 14.58*(1+1.8%/3)=14.66748
and then invest for tow month 14.66748*(1+1.8%/6)=14.7556
convert at the exchange rate which is 120.85, and the final result is 7.08. it is different with the answer, is that right? thanks ahead!There are two problems with what you are doing.
Firstly, just because base rates are 2.2% / 8% certainly does not mean that they can actually borrow and deposit at those rates. We would need to know the rates applicable to their borrowing and depositing in order to do money market hedging.
Secondly, even if we were to do money market hedging, we do not convert twice. We borrow now and convert to euros now and then deposit the euros. We don’t convert them again in four months time.
Thanks John. I understand the point one. So, if I want to use the money market hedge, we must find the borrowing rate and deposit rate clearly in the question, otherwise, we should not use this method. right?
for the point two you answered, I do not convert twice. I also use the regular method.
first borrow the $, then convert to Euro and deposit Euro finally. what’s the meaning about the point you mentioned convert twice? thanksRight, for point 1.
For point 2, maybe I am misunderstand what you originally wrote, but you have steps 1, 2 and 3, which is fine, but then you convert the result again.
ok. I am not convert again, just use the 4.67 to convert the Euro. anyway, thanks John. much clear.
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