- 20 Marks
Question
About one year ago, you were employed by Tesco, an American company based in New York. You work online from home in Nigeria and are a member of the international treasury of Tesco.
Tesco supplies medical equipment to the USA and Europe and also buys some basic raw materials from Europe. It is currently 30 November 2024. On 31 May 2025, Tesco is due to receive CHF16.3 million from a Swiss customer and also to pay CHF4.0 million to a Swiss supplier.
Exchange rates (quoted as US$/CHF1):
- Spot: 1.0292 – 1.0309
- Three months forward: 1.0322 – 1.0341
- Six months forward: 1.0356 – 1.0378
Annual interest rates available to Tesco:
- Switzerland: 3.2% (investing), 4.4% (borrowing)
- USA: 4.6% (investing), 5.8% (borrowing)
Currency futures (contract size CHF125,000, futures price quoted as US$ per CHF1):
- Future price: December – 1.0306, March – 1.0336, June – 1.0369
Currency options (contract size CHF125,000; exercise price quotation US$ per CHF1, premium in US cents per CHF1):
| Calls | Puts | |||||
|---|---|---|---|---|---|---|
| Dec | Mar | June | Dec | Mar | June | |
| 1.0375 | 0.47 | 0.50 | 0.53 | 0.74 | 0.79 | 0.86 |
Required:
- a. Calculate the net receipt if hedged using a forward contract. (4 Marks)
- b. Calculate the net receipt if hedged using money market hedging. (8 Marks)
- c. Calculate the net receipt if hedged using futures. (10 Marks)
- d. Calculate the net receipt if hedged using options. (8 Marks)
(Total: 30 Marks)
Answer
The amount to be hedged is the net receipt, i.e., CHF16.3 million – CHF4.0 million = CHF12.3 million.
i. Forward Contract
- 6-month rate: CHF12,300,000 × $1.0356 = $12,737,880.
ii. Money Market Hedging
- Borrow today at Swiss borrowing rate: CHF12,300,000 / (1 + 0.022) = CHF12,035,225.
- Convert at spot rate to USD and invest at 2.3% for 6 months: $12,386,654.
- Net proceed = $12,671,547.
iii. Futures
- Sell CHF futures to hedge, giving net receipt as $12,740,330.
iv. Options
- Calls and puts premium calculation with CHF futures: Net receipt = $12,655,805.
Explanation:
For each hedging method, we consider the most favorable rates based on the provided figures, including future and option prices, to minimize risk. Futures provide the best outcome with $12,740,330, while options offer flexibility if the exchange rate fluctuates unexpectedly.
Summary of Receipts Using Different Methods:
| Method | Net Receipt ($) |
|---|---|
| Forward Contract | 12,737,880 |
| Money Market | 12,671,547 |
| Futures | 12,740,330 |
| Options | 12,655,805 |
- Tags: Foreign Exchange, Forward Contract, Futures, Hedging, Money market, Options
- Level: Level 3
- Topic: Foreign Exchange Risk Management
- Series: NOV 2023
- Uploader: Dotse