A New Zealand company has a foreign denominated asset in United States dollars worth US$600,000 on the 1 July 2016. The US debtor is due to repay this debt to the New Zealand company over the next 12 months. The repayments are scheduled to take place during the following date. The Spot rate is NZ$ = US$0.72 and the indicative future spot rates are shown in the table below.
Installment 1: 1 October, 2016 (US$150,000) (NZ$ = US$0.71)
Installment 2: 1 January, 2017 (US$150,000) (NZ$ = US$0.73)
Installment 3: 1 April, 2017 (US$150,000) (NZ$ = US$0.75)
Installment 4: 1 July 2017 (US$150,000) (NZ$ = US$0.77)
Required:
a) Describe the risk exposure that the company faces in the above situation.
b) Assuming the company were to hedge its risk, what type of hedge would be more appropriate in this situation. Given reasons for your recommendation.
c) Assume the company is able to hedge the identified risk with a forward rate contract with a negotiated rate of NZ$ = US$0.74.
a. Identify the hedged item and hedge instrument
b. Prepare the journal entries to capture the four installments (receipts)
d) Assume the company are able to partner with another company to secure a swap contract that is potentially beneficial to both parties.
a. Describe the circumstances that the other party may be facing and the motivation that they would have to enter into such an arrangement.
b. Describe what each party to the contract would effectively be required to do under this swap contract.
c. Prepare the journal entries to capture the swap contract for the first and second installment.
Other Information:
Assume the swap contract between the two parties is exactly matched so that their exposure is exactly offset.
When calculating the journal entries, assume the future spot rates are as provided in the above table
The US borrowing rate is 5% while the New Zealand deposit rate is 4%.