Illustration
Problem 7
A UK importer has to pay $ 100,000 in a month’s time. He fears an appreciation of the
dollar. What can he do with the knowledge of the following data?
1 - m interest rate: US$: 4 percent
UK $: 5 percent
Spot rate: $ 1.5537/-$
Solution 7
Since only the money market data are available, the UK importer has to work out
possibilities that exist for him to cover himself in the money market. He can take the
following steps:
(i) Buy S dollars at the spot rate and place them in the money market so as to
obtain $ 100,000 in a month’s time. That is,
1
S [1 + 0.04 X --- ]= 100,000
12
Or
S = $ 99,668.
(ii) In order to buy S dollars, the equivalent amount of pound sterling is
required to be borrowed. The borrowing B is,
99668
B = --------------- = $64,149
1.5537(iii) Refund the sterling loan after one month. The refunded amount would be:
1
R = 64149 [1+ 0.05 X ---]
12= $64,416.3(iv) In the meantime the sum of S dollars placed in the money market would
mature to $ 100,000. Use this sum to pay the payable due.The cost of covering in the money market works out to $ 53.81
100,000
[= 64,416.3 _-----------]