Question

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3 An exporter in the UK has invoiced a customer in the USA the sum of $300,000 receivable in one year's time. He has under consideration two methods of hedging his exchange risk: (a) by borrowing an appropriate amount now for one year, converting the amount into sterling, and repaying the loan out of the eventual receipts. (b) by entering into a 12-month forward exchange contract to sell the $300,000 The sterling-US dollar spot rate is 1.8190-1.8402. The 12-months forward rate of dollars against sterling is 1.7703-1.7915. Interest rates for 12 months are: USA 6.65% UK 9.25%. Your are required to calculate the net proceeds in sterling under each alternative and suggest which is the better alternative. Requirement:

Answer 1

Answel Page No 16 1 Amount to borrow Amount receivable (1 + 0.s interest rate) 300,000 (1+6.65%)' $281,293.95 The amount is converted into € at the spot rate £ received $285,293.95 1.8402 £ 152,860.53 Amount is invested at uk , interest rate for year. € 153,860.53 x (1 +9.25 %) £ received after I year £ 16 7,000.13 After the 1 year the receipt of $ 300,000 from the Coptomer is used to the iNet proceeds £ 167,000:13 repay loan. b Net proceeds Amount vreceivable 12 month forward rate

Page. No 2 Net proceeds $300,000 1.7915 £ 167,457,44 £ 164,457.44 .:. Net proceeds - The net proceeds of forward exchange contract is higher :. The forward exchange contract is better.