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Risk ManagementRisk managementForeign exchange riskMoney market hedgeSection B
This question is part of a case study — click to read the full scenario(Case 26)

Section B - Case 3: Nexus Co

Nexus Co is a UK-based manufacturer of specialized robotics. The company exports to Europe and imports components from Japan. The home currency is the GBP (£).

Nexus Co is due to receive €500,000 from a European customer in 3 months.
Exchange rates available:
Spot rate (EUR/GBP): 1.1520 - 1.1560
3-month forward rate (EUR/GBP): 1.1450 - 1.1500

If Nexus Co uses a forward market hedge, what will be the guaranteed GBP receipt?

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ACCA · Question 27 · Risk Management

Section B - Case 3: Nexus Co

Nexus Co also needs to pay a Japanese supplier ¥50,000,000 in 6 months. The treasurer is considering a Money Market Hedge.

Which of the following steps are required to set up a Money Market Hedge for a future foreign currency PAYMENT? (Select ALL that apply)

Answer options:

A.

Borrow in the home currency (GBP) today.

B.

Borrow in the foreign currency (JPY) today.

C.

Deposit the foreign currency (JPY) in a Japanese bank account today.

D.

Convert the foreign currency to home currency at the future spot rate.

How to approach this question

Think about the timeline. You need JPY in 6 months. To hedge it today, you need to buy JPY today and put it in a bank to grow. To buy it today, you need to borrow GBP.

Full Answer

To hedge a future foreign currency PAYMENT using the money market: 1. Calculate the present value of the foreign liability using the foreign deposit rate. 2. Borrow the equivalent amount in the home currency (GBP) today. 3. Convert the borrowed GBP into the foreign currency (JPY) immediately at today's spot rate. 4. Deposit the JPY in a foreign bank account. With interest, it will grow to exactly the amount needed to pay the supplier in 6 months. 5. In 6 months, pay off the GBP loan with interest.

Common mistakes

Confusing the steps for a payment hedge with a receipt hedge (Option B).
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