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Week 4 Homework

1) What is your new value for the money market hedge? Would this affect your initial decision from reading through section 11-2d? Discuss the drawbacks from using different hedging technique.
When looking at the numbers of the different hedges I found that the call option and forward contract did not change due to the increase in interests rates however the money market hedge did. The discount borrowing rate seems to be the number I see changing that effects the Roll over USD rate for 1-year. Under 5% interest rate it changes to .9524, 6% see .9434, and 9% sees .9174. In each scenario this changes the rollover USD number to $120,247.62 under 5%, $119,113.21 under 6%, and $115,834.86 under the 9% percent rates. The money market hedge seems to take more into account then the other two methods
The drawback of using a money market hedge according to Picardo, (n.d.), is that “The money market hedge, like a forward contract, fixes the exchange rate for a future transaction. This can be good or bad, depending on currency fluctuations until the transaction date. For instance, in the previous example of fixing the euro rate, you would feel really smart if the euro was trading at say 1.40 by vacation time (since you had locked in a rate of 1.3550), but less so if it had plunged to 1.30”. So while it is a good idea for the small time investor for larger investors such as major corporations it may be too costly and not meet their needs.
The drawback of a call option hedge is that it requires a strong knowledge of the market to use even though it is a popular option since the risk is smaller. The problems arise from someone not knowing the different tax laws and the different mechanics involved in trading. This is a good option for the corporation who does not want to take a big risk however you will need someone who is skilled to work the hedge correctly.

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