Managing transaction risk
Assume the following:
The current exchange rate for the Chinese yuan is 6.3159.
The 120-day US interest rate is 2.125%.
The 120-day Chinese interest rate is 4.35%.
The 120-day forward rate for Chinese yuan is 6.3464.
A US firm is required to make a payment of ¥1,000,000 to a supplier in 120 days.
If the value of the Chinese yuan does not change, what will the dollar cost of the payment be?
Describe how the firm can hedge the transaction risk associated with the payment using a money market hedge.
What will the dollar cost of the payment be if the firm hedges the transaction risk with a money market hedge and the spot exchange rate for Chinese yuan in 120 days turns out to be 6.3900?
Describe how the firm can hedge the transaction risk associated with the payment using a forward market hedge.
Explain what will happen using this forward market hedge if the spot exchange rate in 120 days is 6.8900.
Describe how the firm can hedge the transaction risk associated with the payment using a forward market hedge.
Explain what will happen using this forward market hedge if the spot exchange rate in 120 days is 6.8900.