Specimen
1246 others answered this question
Question 3b
ZPS Co, whose home currency is the dollar, took out a fixed-interest peso bank loan several years ago when peso interest rates were relatively cheap compared to dollar interest rates. Economic difficulties have now increased peso interest rates while dollar interest rates have remained relatively stable. ZPS Co must pay interest of 5,000,000 pesos in six months’ time. The following information is available.
Interest rates which can be used by ZPS Co:
| Spot rate: | 12·500–12·582 pesos per $ |
| Six-month forward rate: | 12·805–12·889 pesos per $ |
| Borrow | Deposit | |
|---|---|---|
| Peso interest rates: | 10·0% per year | 7·5% per year |
| Dollar interest rates: | 4·5% per year | 3·5% per year |
Required:
(b) Calculate whether a forward market hedge or a money market hedge should be used to hedge the interest payment of 5 million pesos in six months’ time. Assume that ZPS Co would need to borrow any cash it uses in hedging exchange rate risk. (6 marks)