ACCA Financial Management (F9) Certification Practice Exam

What type of hedge uses both borrowing and lending in domestic and foreign money markets?

1. Forward contract hedge

2. Money market hedge

3. Currency future hedge

4. SWAP agreement

The correct answer is: Money market hedge

A money market hedge involves using borrowing and lending in both domestic and foreign money markets to manage exposure to currency risk. This type of hedge is particularly useful when a company expects to make or receive payments in a foreign currency and wants to lock in the cost or revenue at a known rate. The process typically involves borrowing in the domestic currency and converting it to the foreign currency, or vice versa, to cover anticipated cash flows. By engaging in both borrowing and lending, firms can effectively mitigate the risk that exchange rate fluctuations will adversely impact their future cash flows. This strategy allows them to manage their foreign currency exposure without relying on instruments like forwards or futures. In contrast, a forward contract hedge involves agreeing to exchange a specific amount of currency at a predetermined rate at a future date but does not involve the borrowing or lending of funds. Currency futures operate similarly to forwards but are standardized contracts traded on exchanges. A SWAP agreement allows parties to exchange cash flows, often involving both interest rate and currency elements, but it is structured differently than direct borrowing and lending in the money markets.