Money Market Hedge - Technique?

Hello Jrow,

In fact there is money market hedge for payment and for receipt as well. It is stepwise and it is easier to follow the steps:

The step are as follows, assume you are in UK & trading in US:
1. Borrow appropriate in pounds if you are paying creditor/ in USD for receipt @ spot rate ( amount/ 1+ interest/100)

2. Convert pound to USD immediately/ Convert immediately into home currency.

3. Put USD deposit in USD bank a/c / Deposit in the home currency.

4. When time comes pay the company/ When debtor cash received pay loan

Hope this help.
kreshan@gmail.com

The RULES when it comes to calculating the final proceeds under a money market hedge depend on whether you are:

(1) Hedging a RECEIPT due in a foreign currency from a foreign currency denominated DEBTOR balance on the books (say a $ RECEIPT in 3 months time), or

(2) Hedging a PAYMENT due in a foreign currency, in order to pay off a foreign currency denominated CREDITOR amount in the books (say a $ PAYMENT in 3 months time).

The procedure or steps taken depend on you first of all establishing whether the exposure arises on a foreign debtor or a foreign creditor balance in the books. Note: you can only be asked one or the other.

Money Market Hedge

* Tutor’s note: Applies the “Matching Principle” to hedge Forex Risk – Match asset with liability and vice versa.

An exporter (=>’s Debtor) who invoices in a foreign currency can:

? Borrow “x” in the foreign currency now…. ( Borrow ”x” in $’s now )
? Convert now the foreign currency borrowed into the domestic currency at the spot rate …. ( Convert to £’s now )
? Repay the foreign loan and interest out of the foreign proceeds received from the Debtor
? Add the Deposit Interest earned in £’s


An importer (=>’s Creditor) who has to make a foreign currency payment in the future can:

? Borrow “x” in £’s now
? Convert to $’s now ( Buy the foreign currency now )
? Put it on Deposit in the foreign currency ($’s)
? The interest and principal deposited should be enough to repay the amount due in the foreign currency

In both cases you will have to work backwards to figure out the amount to lend/borrow.

I would advise you to have a look at my Solution to Question 4, especially part (c), of my F9 Mock Exam available to download on the HOME page of the OT website.

Best of luck, Kevin Kelly

thanks very much

actually, sorry. This is the bit that confuses me, do I work out how much I need , just say paying $200, is the first thing to do to convert that at the current spot rate to see how much I need and then is it at the buy or sell rate? Just when I think I have it, I get confused :(

Hi Irow,

If Creditor

You might prefer this order or approach in the case of a CREDITOR for $200

(1) Deposit x $ now
Deposit $ Principal ($200/1+$ int rate)

$ Interest earned + $ principal will cancel out future $200 creditor payment

(2) Borrow x £ now and Convert to $ in order to put the PRINCIPAL on Deposit under step 1 above

Borrow £ - to convert to $ now - to place on Deposit in $ Use the current spot rate for this conversion.... in your example, as we are buying dollars to place on deposit(i.e we will be MULTIPLYING), it will be the lower of the two spot rates quoted.

(3) Add Loan Interest (£) .... to arrive at final cost on settlement date.

Hope this helps, its the WORKING BACKWARDS that causes the confusion. Practice the steps a few times and it should "click" for you.

Regards,Kevin Kelly

Hi Thanks for the information, in fact I ignored Money Market Hedge technique but founf that its really an easy bit.

I have a doubt(perhaps a silly one).
In many questions I found like this,

"Current 3 months interest rates are
US Prime :6.4% - 6.9%
UK LIBOR : 9.2% - 9.9% ".

Could anyone explain to me what is 6.4 and 6.9 stands for in the US Prime rate and also what is 9.2 and 9.9 stands for in the UK LIBOR rate please ???

I am not going to say my assumption as I know its wrong .

Thanks very much in advance.
Jaison Philip

Hi Jaison,

US Prime :6.4% – 6.9%

6.4% is the US Deposit rate for 12 months, not 3 months.

To find the deposit rate for 3 months you will need to divide by 4.

6.9% is the US Borrowing rate for 12 months, again not 3 months!

UK LIBOR : 9.2% – 9.9%.

As above, 9.2% is the deposit rate for 12 months and 9.9% is the Borrowing rate for 12 months.

Regards, Kevin Kelly

but i dint understand the main concept of money market hedge....y do you have to loan when we are having a receipt...and why deposit when we are supposed to pay?.and which currency to convert in case of a receipt and payment .....pls help....

If you are receiving dollars and you are in the UK, then you need to convert dollars into pounds.
The only rate that is certain is the current spot rate, but how can you convert dollars to pounds now at spot if you are not going to receive dollars until (say) three months from now?
The way you do it is to borrow some dollars now -then you are able to convert dollars to pounds at todays spot.
The borrowing will need to be repaid, but when you receive the dollars from the customer you use this to repay the borrowing.

thanks a lot...this really helps