How money market hedge work?

Answer 1

Money Market Hedgeis an internal hedging technique. As a scenario, imagine a UK company with a 1 year receivable of $1,000,000. If the Spot FX rate is 2.000 and US interest rates were 4% and UK interest rates were 5%. The company would borrow $1,000,000 discounted by 4% ($1,000,000/1.04) = $961,538.46, then convert it into Sterling at 2.000 = £480,769.23. The Sterling would then be placed on deposit at 5% (£480,769.23*1.05 = £504,807.69). In one year's time the company receives the expected $1,000,000 and repays the $ loan in full. Therefore the company has hedged the foreign exposure and has enjoyed the Sterling equivalent for the full period. The calculation for the effective Foreign Exchange Forward Outright is $1,000,000/£504,807.69 = 1.98. Forward Outright formula - [Spot-(((1+ih)/(1+if)-1)*Spot)] or [2-(((1.05)/(1.04))-1)*2] Spot=Current FX rate ih=Interest in Home country if=Interest in foreign country JustinPC-10-11-07

Answer 2

A money market hedge works by investing in a portfolio that has stocks that are inversely related in terms of trend movement. In a good hedge setup, the losses of one stock are supplemented by the gains in the other correlated stock.

Answer 3

•This is a synthetic forward

•The firm can use the $ and £ money markets to turn uncertain future $ receipts into known $ receipts today

•Borrow PV of £1m in UK Þ receive £1,000,000/(1+ rfa) = £1,000,000/(1.025)

•Convert into $ today Þ receive $[1,000,000/(1.025)] × 1.764 = $1,720,976

•Owe lender £1m in 90 days Þ repay with £1m payment from UK firm

•So the firm has $ now and has eliminated currency exposure in 90 days