PKR Ltd. has made purchases worth USD 8,00,000 on 1 st May 2020 for which it has to make a payment on 1 st November 2020. The present exchange rate…

CA Final · Advanced Financial Management · RTP · November 2024
PKR Ltd. has made purchases worth USD 8,00,000 on 1 st May 2020 for which it has to make a payment on 1 st November 2020. The present exchange rate is INR/USD 75. The company can purchase forward dollars at INR/USD 74. The company will have to make an upfront premium @ 1 per cent of the forward amount purchased. The company can hedge its position with the following expected rate of USD in foreign exchange market on 1 st May 2020: Exchange Rate Probability (i) INR/USD 77 0.15 (ii) INR/USD 71 0.25 (iii) INR/USD 79 0.20 (iv) INR/USD 74 0.40 You are required to advise the company for a suitable cover for risk assuming that the cost of funds to PKR Ltd. is 10 per cent per annum.

Suggested Answer and Working Notes:

(i) If PKR Ltd. does not take forward cover (Unhedged Position): Expected Rate = 77 × 0.15 +71 × 0.25 +79 × 0.20 +74 × 0.40 = 11.55 +17.75 +15.80 +29.60 = 74.70 Expected Amount Payable = USD 8,00,000 x 74.70 = 5,97,60,000 (ii) If the PKR Ltd. hedge its position in the forward market: Particulars Amount (₹) If company purchases US$ 8,00,000 forward premium is (800000 × 74 × 1%) 5,92,000 Interest on 5,92,000 for 6 months at 10% 29,600 Total hedging cost (a) 6,21,600 Amount to be paid for US$ 8,00,000 @74.00 (b) 5,92,00,000 Total Cost (a) + (b) 5,98,21,600 Advice: Since cash outflow is lesser in case of unhedged position company should opt for the same.

Topics: Foreign Exchange Exposure and Risk Management

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