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Hedging foreign exchange risk

Money Market Hedges (MMH)

5.1 Basic idea

 Avoid future (uncertain) exchange rate by making exchange now
at (known) spot rate.

 This is achieved by depositing/borrowing the foreign currency until
the actual commercial transaction cash flows occur.

5.2 Overview of the method

Future foreign CF? Payment Receipt

 Step 1: borrow Borrow in home currency Borrow in foreign currency

 Step 2: convert Convert to foreign Convert to home currency
currency at spot at spot

 Step 3: deposit Deposit foreign currency Deposit home currency

 Step 4: future Use deposit to pay Receipt from customer
transaction date supplier settles outstanding liability

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