SIC Insurance Company bought a reinsurance product from a foreign reinsurance company in UK. The cost of the reinsurance product is £500,000 payable in 1 year time. Assume that the spot exchange rate is GHS5/£, and the 1-year forward rate is GHS5.5/£. The money market interest rate in Ghana is 15 percent and 10 percent in UK.
i. Describe how SIC can use a forward market hedge to manage this payable.
ii. Calculate the amount to undertake the forward market hedge?
iii. Calculate the gain or loss under the forward market hedge if the spot rate at maturity turns out to be GHS6/£.
iv. What option contract can SIC use to hedge this payable?
v. Suppose the spot rate at maturity is GHS4.7/£. Will SIC be better or worse off under the options market hedge? Assume that the premium is GHS0.001/£ and the strike price is GHS5.5/£.
vi. Describe how SIC can use a money market hedge to manage its exposure. Show the calculation of each step.