Forecasting Cash Flows and Hedging Decision
Response to the following problem:
Virginia Co. has a subsidiary in Hong Kong and in Thailand. Assume that the Hong Kong dollar (HK$) is pegged at $.13 per Hong Kong dollar and it will remain pegged. The Thai baht fluctuates against the U.S. dollar and is presently worth $.03. Virginia Co. expects that during this year, the U.S. inflation rate will be 2 percent, the Thailand inflation rate will be 11 percent, while the Hong Kong inflation rate will be 3 percent. Virginia Co. expects that purchasing power parity will hold for any exchange rate that is not fixed (pegged). Virginia Co. will receive 10 million Thai baht and 10 million Hong Kong dollars at the end of 1 year from its subsidiaries
a. Determine the expected amount of dollars to be received from the Thai subsidiary in 1 year when the baht receivables are converted to U.S. dollars.
b. The Hong Kong subsidiary will send HK$1 million to make a payment for supplies to the Thai subsidiary. Determine the expected amount of baht that will be received by the Thai subsidiary when the Hong Kong dollar receivables are converted to Thai baht
c. Assume that interest rate parity exists. Also assume that the real 1-year interest rate in the United States is 10 percent, while the real interest rate in Thailand is 3.0 percent. Determine the expected amount of dollars to be received by Virginia Co. if it uses a 1-year forward contract today to hedge the receivables of 10 million baht that will arrive in 1 year.