Question about money market hedging

Are you talking about the question which starts “Q is due to pay $8M in 3 months time”?

You don’t borrow the money in 3 months time, you borrow the money now. Here are the steps you take.

1. Work out how many dollars you need to buy now. You are going to invest these dollars, so you only need sufficient dollars that, when interest has accrued, add up to $8M, the amount payable.

2. Exchange now. In other words, but these dollars, at today’s spot rate.

3. Borrow pounds now. The implication is that you don’t have any surplus funds, so the only way you are going to buy dollars is to borrow some pounds now. The amount of pounds you borrow is subject to an interest charge. Therefore, the overall amount you pay for this transaction is the amount of pounds you borrowed, plus the interest you had to pay over 3 months.

Sorry about the misprint.

However, regarding the interest rate – interest rates are always quoted on an annual basis (unless you are specifically told otherwise, which is unlikely).

This is what happens in real life – banks quote annual interest rates, but they quote different annual rates depending on the length of the loan or deposit. So they might (for example) quote 10% p.a. for 3 month deposits, and quote 12% p.a. for 6 month deposits.