Syllabus E. Treasury And Advanced Risk Management Techniques E2. The use of financial derivatives to hedge against forex risk

E2b. Money Market Hedge - Receipt 6 / 13

Syllabus E2b)

b) Evaluate, for a given hedging requirement, which of the following is the most appropriate strategy, given the nature of the underlying position and the risk exposure:

i) The use of the forward exchange market and the creation of a money market hedge

Money Market Hedge - Receipt

The whole idea of a money market hedge is to take the exchange rate NOW even though the receipt is in the future.

By doing this we eliminate the future exchange risk (and possible benefits too of course)

The foreign receipt is in the future, we are going to get eliminate rate risk by getting that foreign currency NOW.

To do this we need to borrow it abroad.

We do not borrow the full amount though, as the receipt will pay off this loan plus interest.

We, therefore, calculate how much is needed now by taking the full amount and discounting it down at the foreign borrowing rate

Now we know how much foreign currency we need NOW, we can convert that into home currency using the spot rate.

Here the bank are buying foreign currency off us and so will BUY HIGH

We then take this home currency and put it on deposit at home

The eventual receipt is the amount converted plus the interest earned at home


  1. Calculate how much foreign currency needed (discount @ foreign borrowing rate)

  2. Convert that to home currency

  3. Deposit that amount of home currency

  4. The receipt will be the amount converted plus interest on that (home currency deposit rate)


Will receive $400,000 in 3 months
Exchange rate now: $1.8250 - 1.8361:£
Forward rates $1.8338 - 1.8452:£
Deposit rates (3 months) UK 4.5% annual US 4.2% annual
Borrowing rates (3 months) UK 5.75% US 5.1% annual

  1. Calculate how much foreign currency needed (discount @ foreign borrowing rate) 

    Interest = 5.1% x 3/12 = 1.275%
    $400,000 x 1/ 1.01275 = $394,964

  2. Convert that to home currency
    The UK company now needs to sell $394,964 from the bank. The bank will BUY HIGH

    394,964 / 1.8361 = £215,110

  3. Deposit that amount of home currency 

    This amount will be deposited at home at 4.5% for 3/12 = 1.125% = 215,110 x 1.125% = £217,530