However, if the anticipated depreciation of the rupee (or appreciation of pound sterling)
does takes place, the company will buy the Rs.X back, with less amount of pounds
sterling. That is, for
25,599,974
-------------- = $ 447,555.99
57.2
The difference between the two ($ 454,545.50 - $ 447,555.99) is equal to the loss ($
6989.51) that would have accrued without hedging.
Illustration
Problem 9
Total translation exposure of a company is Rs.1.5 million. This exposure is in French
francs. Interest rates are 8 and 11 percent for the franc and the rupee respectively. How
is hedging to be done? Spot rate is Rs.6 per FFr. The rupee is likely to depreciate by 6
percent.
Solution 9
Since only the interest rate data is available, the hedging operation is to be done in the
money market. The following steps are involved:
(1) Borrow Rs.1.5 million at 11 percent and convert them into French
Francs at spot rate to obtain: Rs.1.5 million
----------------= 0.25 million FFr
6
(2) Place FFr 0.25 million in the money market for a year at 8 percent.This would give FFr 0.27 million after a year.(3) The sum thus obtained is converted into rupees. If the
anticipated depreciation of 6 percent does take place, the rate
would settle at Rs.6.36/FFr. So, the amount in rupees at the end
of the year would be Rs.(0.27 million X 6.36) = Rs.1.7172
Million.(4) Refund the rupee loan with interest. The refund amount works
out to Rs. (1.5 million X 1.11) = Rs.1.665 million.Thus, the hedging operation would result into a net gain of Rs.52, 200 (=Rs.1.7172)
million – Rs.1.665 million). The gain in French franc would be FFr 8,208.