- 10 Marks
AFM – May 2016 – L3 – Q1b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives, The use of financial derivatives to hedge against interest rate risk
Explain how to hedge a foreign exchange risk exposure using forward and money markets with calculations.
Question
b) A Ghanaian Food and Beverage company has recently imported raw materials from China with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished production and exported finished products to Germany. Consequently, the German customer has been invoiced for US$75,900 payable in three months’ time. Below is the current spot and forward rates for the transactions:
- USD/GHS Spot: 0.9850 – 0.9870
- 3 Months Forward: 0.9545 – 0.9570
Current Money Market rates per annum are as follows:
- US$ (USD): 11% – 13.2%
- Gh¢ (GHS): 12.7% – 14.3%
Required:
i) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure to foreign exchange risk using the Forward Markets. (3 marks)
ii) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure using the Money Markets. (4 marks)
iii) Determine which of the above markets is the best hedging technique. (3 marks)
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