SIC Insurance Company bought a reinsurance product from a foreign reinsurance company in UK. The cost...

i & ii). Forward market hedge - Buy £500,000 forward 12 months at GHS5.5/£

Cost of settlement in 12 months will be 500,000*5.5 = GHS2,750,000

iii). If spot rate at maturity is GHS6/£ then GHS required would be 500,000*6 = GHS3,000,000

Amount saved (or gain) = 3,000,000 - 2,750,000 = GHS250,000

iv). It can be hedged by buying a call option on the £500,000 payable.

v). Since cost of capital for the company is not provided, we will use the money market 15% interest rate in its place.

Option premium = payable*0.001 = GHS500

Premium carried forward for a year = 500*(1+15%) = GHS575

If spot rate at maturity is GHS4.7/£ then the option won't be exercised, so GHS cost of payable will be

500,000*4.7 = GHS2,350,000

Net cost of call option hedge = 2,350,000 + 575 = GHS2,350,575

vi).

Money market hedge: Exchange GHS for £ now and invest it for 12 months.

Payable required in 12 months = £500,000

Discount factor @ UK interest rate = (1+10%) = 1.10

Amount required now = 500,000/1.10 = £454,545.45

GHS at the current spot rate of GHS5/£ = 454.545.45*5 = GHS2,272,727.27

Amount after investing it at 15% for a year = 2,272,727.27*(1+15%) = GHS2,613,636.36 (Cost of settlement after a year)