Question

Shrewsbury Herbal Products, located in central England close to the Welsh border, is an old- line producer of herbal teas, seasonings, and medicines. Its products are marketed all over the United Kingdom and in many parts of continental Europe as well. Shrewsbury Herbal generally invoices in British pound sterling when it sells to foreign customers in order to guard against adverse exchange rate changes. Nevertheless, it has just received an order from a large wholesaler in central France for £320,000 of its products, conditional upon delivery being made in three months' time and the order invoiced in euros. Shrewsbury's controller, Elton Peters, is concerned with whether the pound will appreciate versus the euro over the next three months, thus eliminating all or most of the profit when the euro receivable is paid. He thinks this is an unlikely possibility, but he decides to contact the firm's banker for suggestions about hedging the exchange rate exposure. Mr. Peters learns from the banker that the current spot exchange rate is €/£ is €1.4537. thus the invoice amount should be €465,184. Mr. Peters also learns that the three-month forward rates for the pound and the euro versus the U.S. dollar are $1.8990/£1.00 and $1.3154/€1.00, respectively. The banker offers to set up a forward hedge for selling the euro receivable for pound sterling based on the €/£ forward cross-exchange rate implicit in the forward rates against the dollar. What would you do if you were Mr. Peters?

Answer 1

Geuen > Current spot rate e/E ):4537 3 Month Forward Rates USD / Pound = 1.8990118 QUSD / E coroa 1.3154/1 Euro we need forward be used to create a cross-rate exchange rate which will for selling the euro Since the for it uso is the Base currency for both pairs we will derive the Bid Price USOTE Ewro/USD by reaprocaling - Euro USD - Jaan 0.76092 1.3154 we will multiply it with USD / Pound forward laté o get Euro x USA - 0-76022x1.8990 USO Pound 1.4436 Euro / Pound

1:4436 burol Pound So we we will multiply it with the order seze of 3,20,000 Pounds 3,80,000x14436-4, 61, 973:54 Ewros If I were mr. Peters, I would not take the hedging offer since the amount in total Euros I am getting less than the current invoice amount of 465,18 4 Euros