- 10 Marks
FM – L2 – Q98 – Foreign exchange risk and currency risk management
Question
Accra Food and Beverage Co has recently imported raw materials from Japan with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished products and exported finished products to France. Consequent to this, the French customer has been invoiced for US$75,000 payable in three months’ time. Below is the current spot and forward rates for the transactions:
| USD/GHS | Spot | 3 Months Forward |
|---|---|---|
| 0.9850-0.9870 | 0.9545-0.9570 |
Current money market rates per annum are as follows:
| Currency | Borrowing | Deposits |
|---|---|---|
| US$ (USD) | 11% – 13.2% | 2.7% |
| GH₵ (GHS) | 12.7% – 14.3% | Not provided |
Required:
Demonstrate with relevant calculations how Accra Food and Beverage Co can hedge its exposure to foreign exchange risk using:
(a) The forward markets
(b) The money market
Answer
Since Accra Food and Beverage Co has an asset of USD$75,000 and a liability of USD$264,000, maturing at the same time (3 months), they can be used to offset each other to leave a net liability of USD189,000.
(a) Forward market hedge
Offset $264,000 – $75,000 = USD$189,000
Buy USD$189,000 3 months forward
Cost = $189,000 ÷ 0.9545 = GH₵198,009 payable in 3 months
(b) Money.Concurrent market hedge
- Since the company has a US$ liability, it needs to create a matching US$ asset.
- Place US Dollar on deposit for 3 months at an interest rate of 2.7%.
- Accumulate capital at the end of 3 months to the US$189,000 required.
- Pay off the net liability as follows:
Deposit US$189,000 ÷ (1 + 0.027 × 3/12) = US$189,000 ÷ 1.00675 = US$184,390
The Accra company will have to buy these US$184,390 on the spot market.
Cost = US$184,390 ÷ 0.9850 = GH₵187,198 payable now
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