International Financial management - Essay Example

From here, the borrowed money must be converted into to home currency or pounds sterling using the current spot rate of 1.2834because the company is assumed to invest what it has borrowed to earn interest at UK at 4%. Thus, the future value will be the total amount at £393,447.48 will be received from the foreign exchange transaction at the end of six months. Also, when it is time to pay the foreign currency loan, it will use the foreign currency money it receives from its customer to pay such loan.

Method I is an example of money market hedge where the current spot rate is the only relevant rate and fluctuations in spot rate in the future is not relevant. This can be done by borrowing foreign currency money at a fixed rate at the strength of future receipt of foreign currency. Method 2 on the other hand makes of forward exchange hedge. Note that the exchange rate that is relevant this time is the forward rate as it will determine the cash inflow that the company will receive in the future.

Thus, the current spot rate and the subsequent fluctuations in spot rates during the period of six months are irrelevant. At the date of the contract is entered upon, there are no cash outflows or inflows involved. The cash inflow will happen at the end of the forward contract which is after six months. At six-month time, the company will give to the bank the 500,000 euros that it will receive from its customer. The bank in turn will give to the company the amount of 500,000 euros converted into the forward rate it has agreed with the company.

Comparing the value to be received in Method 1 at £393,447.48 as against £392,003.14 to be received under the Method, there is evidence to choose the former at will give a net advantage of £1,444.34 . The international risks that company faces in relation to changes in foreign exchange rates are divided