Answered: Suppose that you have revenues…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

Suppose that you have revenues denominated in Japanese Yen expected in 6 months.

How would you hedge this risk using money market instruments? How would a money market hedge compare to a forward hedge?

Definition Definition Financial market that deals in securities or assets that are short-term in nature. The money market is responsible for keeping up the liquidity of the businesses and the organizations. These securities are usually held for a period of 12 months or less and are issued by institutions that require cash or funds for their short-term cash flow requirements. The money market is regulated by the federal government.

Expert Solution

How would you hedge this risk using money market instruments?

Answer:-

In order to hedge the currency risk of Japanese yen using money market instrument which is to be received after 6 months, we can borrow an amount in Japanese yen at its present value of the sum to be received after 6 months from a bank at say given rate of "rb" for 6 months.

Present value of loan = Japanese Yen to be received / ( 1 + rb ) ^ 6

At the end of 6 months the loan amount would exactly be = present value of loan * ( 1 + rb ) ^ 6 = Japanese yen received after 6 months which will pay off the loan.