How the firm can hedge the transaction risk

Reference no: EM131920299

Assignment 5 - Transaction risk management

Do this assignment individually.All interest rates are stated as annual rates. Be as specific as possible about all transactions (e.g., amount and currency borrowed or loaned, long or short position, call or put, time of expiration).

Part 1. Managing transaction risk

Assume the following:

The current exchange rate for the Chinese yuan is 6.3159.

The 120-day US interest rate is 2.125%.

The 120-day Chinese interest rate is 4.35%.

The 120-day forward rate for Chinese yuan is 6.3464.

A US firm is required to make a payment of ¥1,000,000 to a supplier in 120 days.

1. If the value of the Chinese yuan does not change, what will the dollar cost of the payment be?

2a. Describe how the firm can hedge the transaction risk associated with the payment using a money market hedge.

b. What will the dollar cost of the payment be if the firm hedges the transaction risk with a money market hedge and the spot exchange rate for Chinese yuan in 120 days turns out to be 6.3900?

3a. Describe how the firm can hedgethe transaction risk associated with the payment using a forward market hedge.

b. Explain what will happen using this forward market hedge if the spot exchange rate in 120 days is 6.8900.

4. Describe how the firm can hedge the transaction risk associated with the payment using a currency option.

5. How could the firm hedge the transaction risk associated with this payment by exposure netting or funds adjustment?

6. How can the firm use leading or lagging to its advantage in connection with this payment?

7. How would the answers to the previous questions change in the firm expected to receive a payment of ¥1,000,000 in 120 days rather than making a payment?

Reference no: EM131920299

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