Using a Money Market Hedge for a Foreign Currency Receivable

Summary

The document presents a money market approach to managing exchange-rate exposure from a future foreign currency receivable. Its example concerns a Japanese exporter expecting a euro payment in one year and supplies borrowing and lending rates for dollars, euros, and yen, together with spot and forward exchange rates. The response works backward from the euro amount due, discounting it at the stated euro borrowing rate to find a present euro amount, then converts that amount through spot exchange rates into dollars and yen.

This illustrates the basic sequence of borrowing in the receivable currency and converting the borrowed funds at current rates to establish a current position tied to the future cash flow. However, the response does not fully reconcile the exporter’s actual receivable, the stated yen exposure, or the interest cash flows on all legs. It also leaves out a clear maturity settlement and does not compare borrowing and lending rates in a complete hedge calculation. Treat the numerical procedure as an incomplete worked answer rather than a comprehensive, verified hedge specification.

Key ideas

• A money market hedge can address foreign exchange exposure from a known future receivable.
• The present amount in the receivable currency is calculated using an interest rate over the remaining term.
• Spot exchange rates convert the present foreign currency amount into other currencies.
• Borrowing and lending rates differ, so the applicable side of each rate quote matters.
• A complete hedge description should specify maturity cash flows and reconcile them with the receivable.

Tags

# Hedging against exchange risk


# Hedging against exchange risk












How does one hedge against any exchange risk?

A Japanese exporter has a €1,000,000 receivable due in one year. Detail a strategy using a money market hdege that will eliminate any exchange rate risk.

1-year rates of interest:

$$ \begin{array}{r|c|c} \text{Currency} & \text{Borrowing} & \text{Lending}\\ \hline Dollar\ (\$) & 4.50\ \% & 4.00\ \% \\ Euro\ (€) & 6.00\ \% & 5.35\ \% \\ Yen\ (¥) & 1.00\ \% & 0.75\ \% \end{array} $$ The spot rates are as follows:

$$ \begin{array}{cc} \ Current\ Spot\ Exchange\ Rates & \ & \ One\ Year\ Forward\ Rates\\ \ \$ 1.25 = €1.00 & \ & \$ 1.2262 = €1.00 \\ \$ 1.00 = ¥1.00 & \ & \$ 1.03 = ¥100 \\\end{array} $$

## Answer by 3kstc (score 1, accepted)

https://quant.stackexchange.com/a/37077

So after much calculations, this is the approach:

In 1 year you need €1,000,000, how much do you need currently ($x$)?

If the euro interest rate is at 6%,

$$ x\ \times\ (1+6\%) = x(1.06) = €\ 1,000,000$$ $$ \begin{align}x\ = \frac{€\ 1,000,000}{1.06} \newline \therefore\ x\ = €\ 943,396.22\end{align}$$

With the current spot rate, we can convert € 943,396.22 into dollars by:

$$€\ 943,396.22 \times \frac{$1.25}{€} = $\ 1,179,245.28$$

You would convert these dollars to yen:

$$\$\ 1,179,245.28 \times \frac{¥\ 100}{$} = ¥\ 117,924,528.30$$

The answer is:

You would borrow € 943,396.22 today. Convert the euro to dollars at the spot exchange rate, convert these dollars to yen at the spot rate, and receive ¥117,924,528.30

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.