Mock exam question – Dec 23 FM

Monty Co, whose domestic currency is the dollar ($), exports to countries whose currency is in Pesos. In 6 months’, time they are expecting a 150,000 peso receipt from a customer.

Monty Co has a supplier in a foreign country whose currency is the dinar (D). In six months’, time, Wren Co must make a payment to the supplier, of D1 million.

Monty Co also wants to compare making a lead payment of D1 million now, with taking out a forward exchange contract for D1 million, that can be exercised in six months’ time. As the company is short of cash, it would need to borrow money for any exchange rate risk hedging.

Exchange Rates Peso to $ Dinars to $
Spot rate 5.78 2.05
Six month forward 5.90 1.98

The following information on current short-term interest rates is available:

Six-month Interest rates Borrowing Deposit
Dollars 2% 1%
Pesos 5% 4%

As a result of the general uncertainty over exchange rates, Monty Co is considering a variety of ways in which to manage its foreign exchange rate risk, including the use of derivatives.

The question asks to calculate the money market hedging for the 150,000 pesos.

The answer is: Borrow in Peso market at 5%
Convert at spot rate
Then deposit in Dollar market at 1%
150,000 pesos / 1.05 / 5.78 x 1.01 = $24,962

I thought we normally calculate 5%x6/12?