Foreign Currency Exposures of Medco Essay Example | Topics and Well Written Essays - 2000 words - 1

Foreign Currency Exposures of Medco - Essay Example This paper illustrates that money market hedging strategy is mainly based upon channelizing the interest rate exposures of the currencies involved i.e. the home currency and the foreign currency. Under the existing scenario, home currency is Pounds whereas the foreign currency is Euros. This strategy has the reciprocal way of dealing with the foreign currency risk in receipt and payment case. As the existing case is the receipt case, therefore, Borrow-then-invest strategy is followed. From the below-mentioned table, it can be viewed that at the first step an amount equivalent to the amount receivable in 6 months i.e. â‚ ¬500,000 are borrowed at an interest rate of 2% per annum equivalent to 1% semi-annually. The amount received from a bank is immediately converted into the amount in pounds at the spot rate of 1.2834 producing a sum of  £385,733. This amount is then invested at a rate of 4% per annum equivalent to 2% semi-annually thus producing a sum  £393,477. Forward exchang e rate hedging is mainly based upon the mechanism of locking in a pre-determined future rate at today’s rate. In another rate, when the invoice amount will be remitted, the exchange rate will not be the spot rate after 6 months rather the exchange rate will be the rate determined today i.e. forward rate. In the existing scenario, the fixed forward for 6 months is 1.2755. After 6 months, when the amount is remitted, â‚ ¬500,000 will be converted at 1.2755 which is the forward rate determined 6 months earlier and will generate a sum of  £392,003. In this way, whether the home currency is appreciated or depreciated against the foreign currency, Medco will take the forward rate as the fixed rate and either the loss or the gain will be the sole liability of the forward rate dealer. From the above two techniques, it is quite evident that the money market hedging strategy is going to yield in a higher amount i.e.  £393,447 as compared to the forward rate based hedging strateg y which will yield in  £392,003. In this way, it can be noted that money market hedging based seems more effective given the interest rates and other factors remains constant. The Board of Directors of Medco is advised to follow money market-based hedging strategy, as the same will earn a marginal benefit of  £1,444 to the company. However, the arrangement of money market hedging will require substantial efforts of management in fulfilling the requirements of the bank providing this money market hedging facility to Medco.