- 10 Marks
Question
b) A Ghanaian Food and Beverage company has recently imported raw materials from China with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished production and exported finished products to Germany. Consequently, the German customer has been invoiced for US$75,900 payable in three months’ time. Below is the current spot and forward rates for the transactions:
- USD/GHS Spot: 0.9850 – 0.9870
- 3 Months Forward: 0.9545 – 0.9570
Current Money Market rates per annum are as follows:
- US$ (USD): 11% – 13.2%
- Gh¢ (GHS): 12.7% – 14.3%
Required:
i) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure to foreign exchange risk using the Forward Markets. (3 marks)
ii) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure using the Money Markets. (4 marks)
iii) Determine which of the above markets is the best hedging technique. (3 marks)
Answer
i) Forward Market Hedge
Offset USD264,000 – USD75,900 = USD189,000 (1 mark)
Buy USD189,000 3 months forward.
Cost = USD189,000 ÷ 0.9545 = GH¢198,009 payable in 3 months (1 mark)
ii) Money Market Hedge
- The company has a US$ liability, so it needs to create a matching US$ asset.
- Place USD on deposit for 3 months at an interest rate of 2.7%.
- Accumulate capital at the end of 3 months to the USD189,000 required.
Step 1:
Deposit USD189,000 needed in 3 months.
Amount to deposit now:
USD189,000 ÷ 1.027 = USD184,390 (1 mark)
Step 2:
The Ghanaian company will have to buy USD184,390 on the spot market.
Cost = USD184,390 ÷ 0.9850 = GH¢187,198 payable now (1 mark)
iii) Best Hedge Market
Now vs. 3 months:
- Forward Market Hedge: GH¢198,009       (0.5 mark)
- Money Market Hedge: GH¢187,198 (0.5 mark)
Compound cost of the Money Market Hedge = GH¢187,198 × (1 + 0.0325) = GH¢193,282 (1 mark)
- Tags: Foreign Exchange Risk, Forward Market, Hedging, Money market
- Level: Level 3
- Uploader: Dotse