Page 230 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Chapter 16

Example 6

RM Plc (a UK company) is due to receive $2.5 million from a customer in 6
months’ time. The treasurer of RM Plc has obtained the following information:

• Spot rate GBP 1/USD 1.5000 – 1.4875

• USD borrowing can be obtained at 6.0%p.a. and deposits pay 3.0%p.a.

• GBP borrowing can be obtained at 7.0%p.a. and deposits pay 4.0%p.a.

Calculate the amount RM Plc will receive in GBP if a money market
hedge is used, to the nearest GBP.

(Round calculations to the nearest £ or $, at each stage of the calculation).

Solution

The hedge requires RM Plc to borrow in $, translate to £ and deposit £. The
receipt from the customer can then be used to repay the loan (plus interest).

6 months Now

Borrow the present value of
$2,500,000 in 6 months’ time. $
Receive Create $ borrowings at 6% for 6 months means
$2,500,000 liability an interest rate of 6% × 6/12 = 3%

$2,500,000/1.03 = $2,427,184

Translate at the spot rate, RM Plc are
selling, so the bank will be buying at
the higher rate:

$2,427,184/1.5000 = £1,618,123

£1,618,123 Deposit £1,618,123 in the UK for 6
This will yield
a return of × 1.02 months.
£1,650,485
<= Interest rate = 4% × 6/12 months = 2%

220