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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:

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

3kstc
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1 Answers1

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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

3kstc
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