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Medium2 marksMultiple Choice
Risk ManagementSection BFinancial ManagementSyllabus HMoney Market Hedge

ACCA · Question 18.2 · Risk Management

CASE 3: GLOBALBEAN CO

GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds.

To hedge the EUR 500,000 receipt using a money market hedge, what is the correct sequence of actions GlobalBean should take today?

Answer options:

A.

Borrow USD, convert to EUR at the spot rate, and deposit the EUR.

B.

Borrow EUR, convert to USD at the spot rate, and deposit the USD.

C.

Deposit EUR, wait three months, and convert to USD at the forward rate.

D.

Buy a EUR call option and sell a USD put option.

How to approach this question

For a future receipt, you want to get the money now. So, borrow the foreign currency, convert it to home currency immediately, and deposit it. Use the future receipt to pay off the loan.

Full Answer

B.Borrow EUR, convert to USD at the spot rate, and deposit the USD.✓ Correct
To hedge a future foreign currency receipt using a money market hedge, the company must create a matching foreign currency liability. Therefore, GlobalBean should borrow EUR today. They then immediately convert the borrowed EUR into USD at the current spot rate and deposit the USD in a US bank. In three months, the EUR 500,000 receipt from the customer is used to pay off the EUR loan.

Common mistakes

Reversing the borrowing and depositing currencies (Option A).
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