Foreign Exchange Risk

FM – L2 – Q102 – Treasury management

PrimeCare Inc supplies medical goods to HealthBridge Ltd in Ghana, addressing credit and currency risks in a $3M contract.

Question

PrimeCare Inc, a company in the USA, has agreed a contract to supply medical supplies to HealthBridge Ltd, a large hospital group based in Ghana. The price of the contract is $3 million.
There is currently no existing relationship between the two companies and PrimeCare has no other customers in Ghana.

Required:
Explain how PrimeCare Inc can manage the credit risk and currency risk associated with this international transaction.

Answer

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Tags: Credit risk, Currency hedging, Foreign Exchange Risk, Forward Contract, International payments, Letter of credit, Treasury management
Level: Level 2

Topic: Treasury Management

FM – L2 – Q98 – Foreign exchange risk and currency risk management

Accra Food and Beverage Co hedges USD189,000 net liability using forward and money market methods.

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

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Tags: Currency hedging, Foreign Exchange Risk, Forward Markets, Forward Rates, Interest rates, Money Markets, Net Exposure, Spot Rates, Transaction risk, USD/GHS
Level: Level 2

Topic: Foreign exchange risk and currency risk management

FM – L2 – Q97 – Hedging with options

UK company hedges $2M USD receipt using currency options, calculates outcome at expiry with given spot rate.

Question

A UK company, PrimeCare Plc, will receive US$2 million in six months’ time. It is now 20th March. The company is not sure whether the US dollar will rise or fall in value against sterling over the next few months, and it has decided to hedge its exposure to currency risk using traded currency options.
On the London Stock Exchange, traded currency options are available in a contract size of £31,250. Options are priced in cents per £1. Assume that option contracts expire on 20th of each month.
The following option prices are currently available:

Exercise price	Calls	Puts
	June	September	June	September
1.8500	1.4	1.9	4.0	5.1

The current spot exchange rate (US$/£1) is 1.8325–1.8375.

Required
(a) Explain how the company’s currency exposure could be hedged using traded currency options.
(b) Show what would happen if the options are still held by the company at expiry and the spot exchange rate is $1.9150–1.9200.

Answer

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Tags: Currency Options, Exchange Rates, Financial Risk Management, Foreign Exchange Risk, Hedging, Sterling, Traded options, US Dollar
Level: Level 2

Topic: Hedging with options

L2 – Q96 – Futures and hedging with futures

US company hedges £400,000 sterling receipt using currency futures, calculating effective exchange rate.

Question

MORE CURRENCY FUTURES
The sterling/US dollar currency future is a contract for £62,500. It is priced in US dollars, and the tick size is $0.0001.
Currency futures are not normally used by companies to hedge currency risks. However, assume that a US company, Apex Innovations Ltd, intends to use currency futures to hedge the following currency exposure.
It is now October. Apex Innovations Ltd expects to receive £400,000 in January from a customer in the UK.
The price of March sterling/US dollar futures is currently 1.8600.
The company is concerned that the value of sterling will fall in the next few months, and it therefore decides to use futures to hedge the exposure to currency risk.

Required
(a) How should Apex Innovations Ltd hedge its currency risk with futures?
(b) Suppose that in January when Apex Innovations Ltd receives the sterling payment, the March futures price is 1.8420 and the spot rate (US$/£1) is 1.8450.
Show what will happen when the futures position is closed, and calculate the effective exchange rate that Apex Innovations Ltd has obtained for the £400,000.

Answer

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Tags: Currency futures, Exchange Rates, Financial Risk Management, Foreign Exchange Risk, Futures contracts, Hedging, Risk Mitigation, Sterling, US Dollar
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q95 – Currency Risk Management

UK company hedges €2,110,000 net euro payment using forward contract, money market hedge, and currency futures; compare costs.

Question

It is now the end of July. A UK company, Zenith Enterprises, expects the following receipts and payments in euros at the end of the month in three months’ time (at the end of October):

| Receipts | €540,000 |
| Payments | €2,650,000 |

The company is concerned about the exposure to a risk of a movement in the sterling/euro exchange rate, and it has decided to hedge the exposure.
It is considering three methods of hedging the exposure:
(a) with a forward exchange contract
(b) using a money market hedge
(c) using currency futures.

Relevant data is as follows:

FX rates, €/£1
Spot	1.4537	1.4542
3 months forward	1.4443	1.4448

3-month interest rates	Borrow	Invest
Sterling (UK)	6.2%	5.6%
Euro	3.8%	3.4%

Currency futures: €/£1
Contract size is €100,000 per contract
December futures price: 0.6929

Required:
Demonstrate with relevant calculations how Zenith Enterprises can hedge its exposure to foreign exchange risk using:
(a) a forward exchange contract (3 marks)
(b) a money market hedge (4 marks)
(c) currency futures (3 marks)
Recommend which method of hedging would be preferable in this situation.

Answer

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Tags: Currency futures, Currency hedging, Euro, Financial Risk Management, Foreign Exchange Risk, Forward Contract, Hedging Strategies, Money Market Hedge, Sterling
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q94 – Futures and hedging with futures

Explain how a Canadian company can hedge USD payment using euro/USD futures.

Question

The euro/US dollar currency future is a contract for €125,000. It is priced in US dollars, and the tick size is $0.0001.

Currency futures are not normally used by companies to hedge currency risks. However, assume that a Canadian company intends to use currency futures to hedge the following currency exposure.

It is now February. The Canadian company has to make a payment of US $640,000 in May to a supplier.

The price of June euro/US dollar futures is currently 1.2800.

The company is concerned that the value of the dollar will increase in the next few months, and it therefore decides to use futures to hedge the exposure to currency risk.

Required

(a) How should the company hedge its currency risk with futures?

(b) Suppose that in May when the company must make the payment in dollars, the June futures price is 1.2690 and the spot rate (US$/€1) is 1.2710.

Show what will happen when the futures position is closed, and calculate the effective exchange rate that the company has obtained for the US $640,000

Answer

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Tags: Basis risk, Currency futures, Effective Exchange Rate, Foreign Exchange Risk, Futures contracts, Hedging
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q93 – Futures and hedging with futures

Illustrate how YSL can hedge FX risk using currency futures for a 140M yen payment.

Question

Zest Inc. is a company located in the USA that has a contract to purchase goods from Japan in two months’ time on 1st September. The payment is to be made in YEN and will total 140 million yen.
The managing director of Zest Inc. wishes to protect the contract against adverse movements in foreign exchange rates and is considering the use of currency futures. The following data are available:
Spot foreign exchange rate $1 = 128.15 yen
Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
Contract size 12,500,000 yen, contract prices are US$ per yen.
Contract prices:
September 0.007985
December 0.008250
Assume that futures contracts mature at the end of the month.

Required:
(a) Illustrate how Zest Inc. might hedge its foreign exchange risk using currency futures.

(b) Assuming spot exchange rate is 120 yen / $1 on 1 September and that basis risk decreases steadily in a linear manner, calculate what the result of the hedge is expected to be. Briefly discuss why this result might not occur.

Answer

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Tags: Basis risk, Currency futures, Foreign Exchange Risk, Hedge efficiency, Hedging, Japan, USA, Yen, YSL
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q90 – Foreign exchange risk and currency risk management

Compare costs of hedging Eurotrade's $500,000 payment using forward contract vs. money market hedge.

Question

The treasurer of Eurotrade Company wants to hedge an exposure to currency risk. Eurotrade is a company whose domestic currency is the euro, and the company must make a payment of US $500,000 to a US supplier in six months’ time.
The following market rates are available:

Six month interest rates

	Borrowing	Deposits
Euro	4.8%	4.4%
US dollar	2.5%	2.0%

(These interest rates are expressed as an annual rate of interest.)

Required
Compare the cost of hedging the currency risk exposure with:
(a) a forward exchange contract (3 marks)
(b) a money market hedge. (5 marks)
Recommend which method of hedging would be preferable in this situation.

Answer

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Tags: Currency hedging, Euro, Foreign Exchange Risk, Forward Contract, Money Market Hedge, Transaction exposure, US Dollar
Level: Level 2

Topic: Foreign exchange risk and currency risk management

FM – L2 – Q88 – Money Market Hedge

Calculate money market hedge for $600,000 USD receipt in 6 months and estimate 6-month forward exchange rate for BritCo Ltd.

Question

BritCo Ltd expects to receive $600,000 in six months’ time from a customer. It intends to convert these dollars into sterling.
The current spot rate for the dollar against sterling (GBP/USD) is 1.8800. The six-month interest rates are 5% per year for sterling and 3.5% per year for the US dollar.

Required
(a) Show how BritCo Ltd can create a money market hedge for its exposure to a fall in the value of the dollar.
(b) Estimate what the exchange rate should be for a six-month forward contract, GBP/USD.

Answer

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Tags: Currency Risk Management, Foreign Exchange Risk, Forward Contract, Hedging, Interest rates, Money Market Hedge, Sterling, US Dollar
Level: Level 2

Topic: Treasury Management

Tag (SQ): Foreign Exchange Risk

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FM – L2 – Q102 – Treasury management

PrimeCare Inc supplies medical goods to HealthBridge Ltd in Ghana, addressing credit and currency risks in a $3M contract.

FM – L2 – Q98 – Foreign exchange risk and currency risk management

Accra Food and Beverage Co hedges USD189,000 net liability using forward and money market methods.

FM – L2 – Q97 – Hedging with options

UK company hedges $2M USD receipt using currency options, calculates outcome at expiry with given spot rate.

L2 – Q96 – Futures and hedging with futures

US company hedges £400,000 sterling receipt using currency futures, calculating effective exchange rate.

FM – L2 – Q95 – Currency Risk Management

UK company hedges €2,110,000 net euro payment using forward contract, money market hedge, and currency futures; compare costs.

FM – L2 – Q94 – Futures and hedging with futures

Explain how a Canadian company can hedge USD payment using euro/USD futures.

FM – L2 – Q93 – Futures and hedging with futures

Illustrate how YSL can hedge FX risk using currency futures for a 140M yen payment.

FM – L2 – Q90 – Foreign exchange risk and currency risk management

Compare costs of hedging Eurotrade's $500,000 payment using forward contract vs. money market hedge.

FM – L2 – Q88 – Money Market Hedge

Calculate money market hedge for $600,000 USD receipt in 6 months and estimate 6-month forward exchange rate for BritCo Ltd.

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FM – L2 – Q102 – Treasury management

PrimeCare Inc supplies medical goods to HealthBridge Ltd in Ghana, addressing credit and currency risks in a $3M contract.

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FM – L2 – Q98 – Foreign exchange risk and currency risk management

Accra Food and Beverage Co hedges USD189,000 net liability using forward and money market methods.

You're reporting an error for "FM – L2 – Q98 – Foreign exchange risk and currency risk management"

FM – L2 – Q97 – Hedging with options

UK company hedges $2M USD receipt using currency options, calculates outcome at expiry with given spot rate.

You're reporting an error for "FM – L2 – Q97 – Hedging with options"

L2 – Q96 – Futures and hedging with futures

US company hedges £400,000 sterling receipt using currency futures, calculating effective exchange rate.

You're reporting an error for "L2 – Q96 – Futures and hedging with futures"

FM – L2 – Q95 – Currency Risk Management

UK company hedges €2,110,000 net euro payment using forward contract, money market hedge, and currency futures; compare costs.

You're reporting an error for "FM – L2 – Q95 – Currency Risk Management"

FM – L2 – Q94 – Futures and hedging with futures

Explain how a Canadian company can hedge USD payment using euro/USD futures.

You're reporting an error for "FM – L2 – Q94 – Futures and hedging with futures"

FM – L2 – Q93 – Futures and hedging with futures

Illustrate how YSL can hedge FX risk using currency futures for a 140M yen payment.

You're reporting an error for "FM – L2 – Q93 – Futures and hedging with futures"

FM – L2 – Q90 – Foreign exchange risk and currency risk management

Compare costs of hedging Eurotrade's $500,000 payment using forward contract vs. money market hedge.

You're reporting an error for "FM – L2 – Q90 – Foreign exchange risk and currency risk management"

FM – L2 – Q88 – Money Market Hedge

Calculate money market hedge for $600,000 USD receipt in 6 months and estimate 6-month forward exchange rate for BritCo Ltd.

You're reporting an error for "FM – L2 – Q88 – Money Market Hedge"

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