A U.S. based firm has a payable of euro 42,500,000 which will be paid 3 months from today.

The firm-specific interest rate for borrowing $ is 2%, and the firm can invest euros at a rate of return of 6%. The spot exchange rate is 1.1 €/$. 

Calculate the amount of dollars paid with a money market hedge.

Suppose the firm is also considering using a forward contract. The market rate of interest for $ is 3%, and the market rate of interest on

euros is 8%.

Calculate the amount of dollars paid with a forward contract hedge. Is the money market hedge or the forward contract hedge preferred by the firm? Explain.

Finally, suppose the firm did not have the possibilities  but rather had to borrow and invest at the market rates.

Show that the money market hedge would now be identical to a forward contract hedge.

Answer rating: 100% (QA)

To calculate the amount of dollars paid with a money market hedge we first need to calculate the euro amount in 3 months if the firm invests in euros Using the formula Future value present value x 1 i... View the full answer