Question

Calculate the Profit from hedging.
A US exporter receives £25,000 in a year. The spot exchange rate is $1.23 for £1.
Interest rates :
Borrowing = 6%
Deposit = 5%
Interest rates $:
Borrowing = 12%
Deposit = 10%
The expected spot exchange rate in a year is $1.25.
a) $500
b) $550.
c) $600
d) $660.

Answer 1

Answer:

Option (c) is the answer...

Answer 2

Answer:

Option (d) is correct

Explanation:

The exporter will receive pound 25000 after one year.

Current spot rate: 1 pound = $1.23

Let's borrow pound Y for 1 year at 6%

then Y + .06Y = 25,000 pounds

Y = 23,584.90 pounds to be borrowed today which when repaid after an year would amount to pound 25000.

Now, convert these pounds into US $ based upon spot rate today i.e

1 pound = $1.23 and receive, 23584.90 × 1.23 = $29009.43 as on today.

Invest,  $29009.43 today at 10% rate of interest and receive after one year,

= 29009.43 ( 1 + .10) = $31,910.377 approx.

Now, reconvert the above proceeds into pounds based upon the expected spot rate 1 year hence i.e 1 pound = $ 1.25 , and receive pounds

= $\frac{31910.377}{1.25}$

=  25,528.30 pounds

Thus, money repaid from receipts = 25000 pounds

money received = 25528.30 pounds

Thus, gain from hedging = 528.30 pounds convertible into dollars at spot rate of $1.25 = 528.30 × 1.25 = $660.377 approx.

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