Let's solve the given problem using both a forward market hedge and a money market hedge step-by-step.
### Forward Market Hedge
Step 1: Calculate the amount in Euros that will be equivalent to [tex]$350,000 at the forward rate.
The six-month forward rate given is 1.155 ($[/tex]/€).
[tex]\[
\text{Euro equivalent forward} = \frac{\$350,000}{\text{Forward rate}} = \frac{350,000}{1.155}
\][/tex]
[tex]\[
\text{Euro equivalent forward} \approx 303,030.30 \, \text{Euros}
\][/tex]
### Money Market Hedge
Step 1: Calculate the present value of the Euros needed to be borrowed now.
The annual borrowing interest rate for Euros is 14%.
[tex]\[
\text{Monthly interest rate for Euros} = \frac{0.14}{12} \approx 0.01167 \, \text{(or 1.167% per month)}
\][/tex]
For a 6-month period, the interest rate would be:
[tex]\[
\text{Interest rate for 6 months} = 1 + (0.14 \times \frac{6}{12}) = 1 + 0.07 = 1.07
\][/tex]
Thus, the present value of Euros to be borrowed now:
[tex]\[
\text{Euro present value} = \frac{303,030.30 \, \text{Euros}}{1.07} \approx 283,205.89 \, \text{Euros}
\][/tex]
Step 2: Convert this amount of Euros to USD at the spot rate.
The spot rate given is 1.166 ([tex]$/€).
\[
\text{USD equivalent of present value} = 283,205.89 \, \text{Euros} \times 1.166 = 330,218.07 \, \text{USD}
\]
Step 3: Invest this amount in the USD market at the deposit rate.
The annual deposit interest rate for USD is 4%.
\[
\text{Monthly interest rate for USD} = \frac{0.04}{12} \approx 0.00333 \, \text{(or 0.333% per month)}
\]
For a 6-month period, the interest rate would be:
\[
\text{Interest rate for 6 months} = 1 + (0.04 \times \frac{6}{12}) = 1 + 0.02 = 1.02
\]
\[
\text{Future value of USD investment} = 330,218.07 \, \text{USD} \times 1.02 \approx 336,822.43 \, \text{USD}
\]
By following these steps, the firm can hedge its currency exposure through both the forward market and the money market. The results show:
1. For the Forward Market Hedge, the firm would need to have €303,030.30 in six months.
2. For the Money Market Hedge, the firm would borrow approximately €283,205.89 now, convert that to $[/tex]330,218.07 using the spot rate, and invest this amount in USD to get approximately [tex]$336,822.43 in six months.
Both methods would ensure that the firm is protected against currency fluctuation risks for its payable amount of $[/tex]350,000 due in six months.
