International Financial Management 2nd Edition by Geert Bekaert ,Robert Hodrick

Exercise 1

You are a sales manager for Motorola and export cellular phones from the United States to other countries. You have just signed a deal to ship phones to a British distributor, and you will receive £700,000 when the phones arrive in London in 180 days. Assume that you can borrow and lend at 7% p.a. in U.S. dollars and at 10% p.a. in British pounds. Both interest rate quotes are for a 360-day year. The spot rate is $1.4945/£, and the 180-day forward rate is $1.4802/£.
a. Describe the nature and extent of your transaction foreign exchange risk.
b. Describe two ways of eliminating the transaction foreign exchange risk.
c. Which of the alternatives in part b is superior d. Assume that the dollar interest rate and the exchange rates are correct. Determine what sterling interest rate would make your firm indifferent between the two alternative hedges.