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Hello,
Unfortuantely I still don’t fully get the rule around which figure to use for exchange rates I thought the rule was for whichever currency is quoted first, the first amount given is if you are buying that currency and the second figure is if you are selling it, but it doesn’t seem to always follow through in the examples?
I am looking at Q. Kenduri co (6/13). which gives a spot of $/£ 1.5938 – 1.5962 and a 3 month forward of $/£ 1.5996 – 1.6037. And the question involves making a UK company making a payment of dollars. Therefore to to buy the dollars in 3 months we divide by the 1.5996 which goes with the rule above.
However the next part of the question does a money market hedge. In which it invests dollars, and then when switching the dollars to pounds so selling the dollars, the answer uses the 1.5938 spot rate, shouldn’t it use the 1.5962 one?
Then later in the question when calculating the options, it tranfers the premium calculated in dollars to pounds, and again uses the 1.5938 spot rate, but I don’t understand why if it is selling dollars for pounds?I hope this makes sense sorry for the long question.
Thanks,
AlexWith regard to the money market hedge, I think it is the way the examiner has worded his answer that has confused you.
Because they are having to pay $’s in 3 months time, they need to borrow Pounds now so that they can buy $’s now, so that they can then invest the $’s for 3 months. At the end of 3 months the $’s will have earned interest To calculate the $’s we need to invest and therefore the Pounds we need to borrow means working backwards as the answer does. However it is dollars that they are buying and therefore it is correct to use 1.5938.
(Have you watched my free lectures on money market hedging?)With regard to the option premium, they have to pay the premium and since it is in $’s they have to buy $’s in order to be able to pay it.
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