HEDGING PAYABLES Assume that the Santa Barbara Co in the Uni

HEDGING PAYABLES Assume that the Santa Barbara Co. in the United States will need 300,000 ringgit in 90 days. It wishes to hedge this payables position. Would it be better off using a forward hedge or a money market hedge? Substantiate your answer with estimated costs for each type of hedge. AD%Assume this is already adjusted to be a rate for just 90days 3.0%Assume this is olready adjusted to be arateforjust 90 days 90-day US interest rate 4% 90-day Malaysian interest rates 3% Spot rate of Malaysian ringgit $.404 Effective amount paid for the 300,000 ringgits if a money markte hedge is used 0.400 0.404

Solution

If firm Uses Forward Hedge:

Payout = Exposure * Forward Rate in 90 days

Payout = 3,00,000 ringgit * $0.400/ringitt

Payout = $1,20,000

If firm uses money market hedge:

Investment = 3,00,000 / 1.03

= 2,91,262 ringgit

If we invest 2,91,262 ringgit,we will get 3,00,000 ringgit in 90 days.

For that we need to barrow

Barrow = 2,91,262 * 0.404

= $1,17,670

Loan Repayment = $1,17,670 * 1.04

= $1,22,377

Hence

Payout = $1,22,377

Using forward hedge payout = $1,20,000

Using MMH payout = $1,22,377

Since Forwrad hedge having lesser payoutt,Firm need to take forward hedge.