A U.S. based firm has a receivable of Norwegian krone (NKr) of NKr 22,356,322, which will...

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A U.S. based firm has a receivable of Norwegian krone (NKr) ofNKr 22,356,322, which will be received 110 days from today.
(a) The firm-specific interest rate for borrowing NKr is 4%, andthe firm can invest dollars internally at a rate of return of 12%.The spot exchange rate is 7.5 NKr/$. Calculate the amount ofdollars received with a money market hedge.
(b) Suppose the firm is also considering using a forward contract.The market rate of interest for NKr is 3.6%, and the market rate ofinterest in dollars is 9%. Calculate the amount of dollars receivedwith a forward contract hedge. Is the money market hedge or theforward contract hedge preferred by the firm? Explain.
(c) Finally, suppose the firm did not have the possibilities in(a), but rather had to borrow and invest at the market rates givenin (b). Show that the money market hedge would now be identical toa forward contract hedge.

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4.1 Ratings (510 Votes)

a Money market hedge The firm has a receivable of NKr so let it borrow USD PV of NKr receivable receivable1interest raten 223563221 43651101 2209003121 Amount of dollar to be borrowed PV of NKr See Answer

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A U.S. based firm has a receivable of Norwegian krone (NKr) ofNKr 22,356,322, which will be received 110 days from today.(a) The firm-specific interest rate for borrowing NKr is 4%, andthe firm can invest dollars internally at a rate of return of 12%.The spot exchange rate is 7.5 NKr/$. Calculate the amount ofdollars received with a money market hedge.(b) Suppose the firm is also considering using a forward contract.The market rate of interest for NKr is 3.6%, and the market rate ofinterest in dollars is 9%. Calculate the amount of dollars receivedwith a forward contract hedge. Is the money market hedge or theforward contract hedge preferred by the firm? Explain.(c) Finally, suppose the firm did not have the possibilities in(a), but rather had to borrow and invest at the market rates givenin (b). Show that the money market hedge would now be identical toa forward contract hedge.