Page 194 - AFM Integrated Workbook STUDENT S18-J19

Chapter 10

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 Advantages and disadvantages of MMH

ADVANTAGES DISADVANTAGES

 No currency risk  Complex

 Fairly low transaction costs  May be difficult to get overseas loan

 Offer flexibility  A company with a large overdraft
may struggle to borrow funds now
 May be able to use when forward
contracts not available

5.3 Parity theory

 Interest Rate Parity theory implies that a forward contract and a MMH should
give the same result.

Illustrations and further practice

Now try TYU 2 in Chapter 10

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