A Ghanaian Food and Beverage company has recently imported raw materials from China with an invoice value of US$264,000 payable in three months’ time. Due to the Company’s efficient production capacity, it has finished production and exported finished products to Germany. Consequent to this, the German Customer has been invoiced for US$75,900 payable in three months’ time. Below is the current spot and forward rates for the transactions:
Current Money Market rates per annum are as follows:
US$ (USD): 11% – 13.2%
Gh¢ (GHS): 12.7% – 14.3%
USD/GHS
Spot: 0.9850 – 0.9870
3 Months Forward: 0.9545 – 0.9570
Required:
Demonstrate with relevant calculations how the Ghanaian Company can hedge its exposure to foreign exchange risk using:
i) The Forward Markets. (3 marks)
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Since the Ghanaian Company has an asset of USD$75,000 and a liability of USD$264,000, maturing at the same time (3 months) they can be used to offset each other to leave a net liability of USD189,000.
Forward Market Hedge
Offset $254,000 – $75,000 = USD$189,000
Buy USD$189,000 3 months forward
Cost = $189,000 ÷ 0.9545 = GH¢198,009 payable in 3 months
ii) The Money Markets. (4 marks)
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* Since the company has a US$ liability it needs to create a matching US$ assets
* Place US Dollar on deposit for 3 months at an interest rate of 2.7%
* Accumulate capital at the end of 3 months to the US$189,000 required
* Pay off the net liability as follows
Deposit US$ (1 + 0.025) = USA$189,000 required in 3 months
Amount to deposit now:
US$189,000 ÷ 1.025 = 184,390
The Ghanaian company will have to buy these US$184,390 on the spot market.
Cost = US$184,390 ÷ 0.9850 = GH¢187,198 payable now
iii) Determine which of the above markets the best hedging technique is. (3 marks)
View Solution
. Now 3 months Time
Forward Market (GH¢198,009)
Money Market: (GH187,198)
Compound cost of the Money Market Hedge = 187,198 (1+0.0325)
. = GH¢193,282
As this is lesser amount than the Forward Market Hedge, it can be concluded that the money market hedge is the least cost method of hedging the company’s net liability.