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  1. Hi Mr Moffat,

    I have watched the bit of the lecture regarding exchange rates twice and I understand we always use the rate that makes us worse off. However, I am having trouble in knowing confidently when to divide or multiply by the rate when attempting the examples.

    Am I missing a key rule?

    • It is better to think through the logic carefully rather than just learn a rule.

      If the exchange rate is 1.5 $’s = 1 €, then when converting from $’s to €’s you divide. When converting from €’s to $’s you multiply.

  3. Hi John,

    For example 7, if the company has enough cash reserve (4.86 million pounds) to withdraw & convert to dollars and hence not requiring to borrow the money. The effective cost will only be the lost in interest gained from that amount for 3 months and the interest rate used should be the lower one (9.2%, for deposits) instead of 9.9%.

    Is the above statement correct? and can this situation appear in the exam questions?

    Regards,
    YuSheng

  4. So John, from the above example, we assume the interest rate is calculated on a simple interest rate, that’s why we divide the annual rate directly to get the three months rate?

    Furthermore, if it is required to use effective rate, will the examiner state it clearly??

    thank in advance….

  5. So to reduce the Risk of changing rates we accept the fact that 1 they could change in our favour and 2 that we actually pay more interest due to difference in borrowing and depositing rates? Guess because the exchange fluctuations give higher cashflow differences? I cant see any other good reason otherwise. Really love this paper so far. Just want to fully understand.

    • The purpose of money market hedging is not to gain or lose money, but to effectively fix the exchange rate on a future date.

      The end result of a money market hedge is that when you receive or pay the foreign currency on a future date, the equivalent home currency receipt or payment is fixed.

      If we did not do it and just waiting to see what the spot rate was on the future date, then we would not be certain as to what the result would be, and this is why there would be risk.

  6. If the examiner asks that which is cheaper option from the money market hedging or forward rates?
    1. If we are receiving, then the higher we receive from any specific option, the better/cheaper it is.
    2. If we are paying, then the lower we pay from any specific option, the better/cheaper it is.

    Please confirm that the above two statements are correct for the answer. Thanks.

  7. Hi John,

    Firstly, thank you for your lectures.

    Secondly, in example 7 – the third step where we borrow £’s of £4,980,494 – could we not borrow enough so that when the interest is added on, we end up paying back exactly what we needed to borrow? For example, we borrow £4,980,494 less the interest, so then in 3 months time the borrowings plus the interest would equal the £4,860,206 we need to convert to deposit?

    Or am I missing the point?

    Danielle

  9. Dear Sir, I’ve gone through the questions and answers in case similar questions to mine were already asked and resolved, my question is partly similar to Sam and I refer to your comment on 08 May 2014 regarding example 7. Before coming to my question, i’d like to sum up abit. In example 6, there was a receivable in $ and we did the following which perfectly makes sense:

    1. Borrow $ NOW
    2. Convert to £ at today’s rate
    3. Deposit £

    In example 7, There’s a payable in $, but we changed the sequence of the above

    1. Deposit $ NOW
    2. Convert to $ to £ at today’s rate
    3. Borrow £

    I have 3 questions regarding this:

    a) if the 1st step is to deposit $, from where does the company get that money? ( Does it already have it in hand?) if yes then they could very well convert £ to $ at today;s rate and deposit $ at a fixed rate, why the borrowing afterwards.

    b) Assuming the company does not have the cash in hand, will it be sensible if we go exactly as per eg 6. We borrow to have the money first(in $), then we convert to £ and deposit to receive fixed interest. The reason i’m asking this is because if the company does not have cash how will it be able to make a deposit at the place prior to a borrowing.

    c) In the exam, we assume the company is always UK based unless otherwise stated, correct?

    • The steps you have listed are correct, and in example 7 we do need to borrow GBP first in order to be able to convert to $’s in order to be able to deposit $’s.

      However, you cannot calculate how many GBP you need to borrow, without first calculating how many $’s you need to invest. So as far as the calculations are concerned, we need to perform them in the order listed.

      (I do suggest that you watch the lecture again, and think about what I have just written)

      The question will always tell you what currency the company is using.

  10. Dear John, I have a question. Its a simple one, but i am not been able to answer it myself. When converting $ 7,874,015 to Pounds. Why did you use the rate 1.6201 instead of 1.6283. As i recall your theory when we have to convert to pound we will use the rate which will give us the fewer pounds. Because bank makes the profit. So in this case we should use 1.6283 because it will give us fewer pounds. Please explain

  11. Hi John,

    In Example 7 why did we need the third step when we calculated the amount in dollars that we need to borrow and converted that into pounds at the spot rate so effectively we have avoided the risk of any future exchange rate movements.

    You say that to avoid any payment of pounds today but we don’t have to pay today anyways.

    Thanks.

    • In Example 7 they are not borrowing dollars – they are depositing them.

      They need to buy dollars today in order to be able to deposit them. That means paying out pounds now in order to pay for the dollars.

      Rather than pay out pounds now (when otherwise they wouldn’t be paying the supplies for 3 months) they borrow the pounds now and only repay in 3 months.

  12. Hello John,

    I have a doubt in example 7 if you could help.
    In our first step when we had deposited “7,8874,016”, we had bought this amount of dollars from bank(am not sure if we buy from bank, but in lecture you said we buy the dollars and deposit them for 3 months), then we convert $ to pound after that we borrow the converted amount for 3 months. Now in 3 months time firstly we need to repay our borrowings of “4980494” and the customer will get $8M from our deposits.

    As per this haven’t we paid twice? Once while buying the $ for depositing(which in turn customer will get) and secondly we will also need to repay the borrowings.

  14. Hello,

    I seem to be having an issue with the spot rate to choose.
    In this example, don’t we need to sell dollar when calculating the (now)value in pounds?

    Please do advise me. I did get previous work examples right so I am a bit confused here.

  19. The way I understand it is if we have an asset (which will be money coming in in 3 months time, we have to create a liability in the currency we will be receiving…..eg if we are expecting a payment 0f 300,000 pounds and we are in the US….if the pounds interest rate (borrowing) is 15% pa….we are going to borrow 289156.63…..(15/12 multiply by 3 = 3.75% – which is .0375 —-( 300,000 pounds divided by 1.0375 = 289156.63). We then convert to US at the spot rate and deposit for 3 months at the US deposit rate. At the end of the 3 months, we are owing exactly 300000 pounds.

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