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Sir,
I have a struggle on money market hedging. I came across a question that needed the
receipt to be hedged in 5 months time but the 3-month forward and 1 year forward were
given including the spot. I understand that we will need to interpolate to get the five month
forwards and hence it is a straight calculation for forward. The information given for the
money market hedge consists of interest rates for up to 6 months for the currencies in
question. My main question is how am i gonna go about the money market hedge?
Thank you
The interest rates are for ‘up to 6 months’ and (as always) are quoted as annual rates.
So for 5 months borrowing or depositing the interest rate will be the same as the 6 month rate.
So (for example) since the sterling borrowing rate is 5.5%, the interest you would use if you were borrowing sterling for 5 months is 5/12 x 5.5%.
Yes, after using the interest rate for 5 months to get the amount to be borrowed now in pounds, I still was not able to get the figure according to the solution. However, the question goes thus;
Lammer plc is a UK based company that regularly trades with companies in the USA. Several large transactions are due in five months time. these are shown below. The transactions are in ‘000 units of the currencies shown.
Assume now is 1 June and that futures and options contracts mature at the relevant month end.
net receipts is $1150000
exchange rates: $US/POUNDS
spot 1.9156-1.9210
3 months forward 1.9066-1.9120
1 year forward 1.8901-1.8945Annual interest rates available to lammer plc
sterling up to 6 months 5.5%-4.2%
dollar up to 6 months 4.0%-2.0%Thank you
I am sorry Maryam, but I really cannot type out a full answer here.
You obviously have an answer in the Kaplan kit, so say which bit of it is causing you a problem and then I will try and help.
(I assume that you have watched the free lectures on money market hedging, and that you are borrowing dollars, converting to GBP at the current spot, and then depositing the GBP’s? You have written about borrowing GBP, but since they will be receiving $’s, it is $’s that the will borrow now (and then the receipt will pay off the borrowing))
Hi John, when calculating options, how to know that we have to take Dec prices? The question hasn’t even stated the “today’s date”.
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