Your firm is a U.K.-based exporter of British bicycles.You have sold an order to an Italian firm for €1,000,000 worth of bicycles.Payment from the Italian firm (in €)is due in twelve months.Your firm wants to hedge the receivable into pounds.Not dollars.Interest rates are 3 percent in €,2 percent in $ and 4 percent in £.

Country U.S.S equiv. Currency per U.S.$

Tuesday Monday Tuesday Monday

Britain(pound)£62,500 1.6000 1.6100 0.625 0.6211

1 Month Forward 1.6100 1.6300 0.6211 0.6173

3 Months Forward 1.6300 1.6600 0.6173 0.6024

6 Months Forward 1.6600 1.7200 0.6024 0.5814

12 Months Forward 1.7200 1.8000 0.5814 0.5556

Euro €62,500 1.2000 1.2000 0.833333 0.833333

1 Month Forward 1.2100 1.2100 0.82645 0.82645

3 Months Forward 1.2300 1.2300 0.813008 0.813008

6 Months Forward 1.2600 1.2600 0.793651 0.793651

12 Months Forward 1.2900 1.3200 0.775194 0.757575

Detail a strategy using spot exchange rates and borrowing or lending that will hedge your exchange rate risk. A)Borrow €970,873.79 in one year you owe €1m,which will be financed with the receivable.Convert €970,873.79 to dollars at spot,receive $1,165,048.54.Convert dollars to pounds at spot,receive £728,155.34. B)Sell €1m forward using 16 contracts at $1.20 per €1.Buy £750,000 forward using 12 contracts at $1.60 per £1. C)Sell €1m forward using 16 contracts at the forward rate of $1.29 per €1.Buy £750,000 forward using 12 contracts at the forward rate of $1.72 per £1. D)none of the options

Question

Your firm is a U.K.-based exporter of British bicycles.You have sold an order to an Italian firm for €1,000,000 worth of bicycles.Payment from the Italian firm (in €)is due in twelve months.Your firm wants to hedge the receivable into pounds.Not dollars.Interest rates are 3 percent in €,2 percent in $ and 4 percent in £.

Country	U.S.S equiv.		Currency per U.S.$
	Tuesday	Monday	Tuesday	Monday
Britain(pound)£62,500	1.6000	1.6100	0.625	0.6211
1 Month Forward	1.6100	1.6300	0.6211	0.6173
3 Months Forward	1.6300	1.6600	0.6173	0.6024
6 Months Forward	1.6600	1.7200	0.6024	0.5814
12 Months Forward	1.7200	1.8000	0.5814	0.5556
Euro €62,500	1.2000	1.2000	0.833333	0.833333
1 Month Forward	1.2100	1.2100	0.82645	0.82645
3 Months Forward	1.2300	1.2300	0.813008	0.813008
6 Months Forward	1.2600	1.2600	0.793651	0.793651
12 Months Forward	1.2900	1.3200	0.775194	0.757575

Detail a strategy using spot exchange rates and borrowing or lending that will hedge your exchange rate risk. A)Borrow €970,873.79 in one year you owe €1m,which will be financed with the receivable.Convert €970,873.79 to dollars at spot,receive $1,165,048.54.Convert dollars to pounds at spot,receive £728,155.34. B)Sell €1m forward using 16 contracts at $1.20 per €1.Buy £750,000 forward using 12 contracts at $1.60 per £1. C)Sell €1m forward using 16 contracts at the forward rate of $1.29 per €1.Buy £750,000 forward using 12 contracts at the forward rate of $1.72 per £1. D)none of the options

Quizplus · Accepted Answer

Option A involves borrowing in Euros at a lower interest rate and then converting the Euros to pounds using spot exchange rates. This locks in the exchange rate and eliminates the risk of any future exchange rate fluctuations. Selling Euros forward in option B and C involves a higher cost due to the premium paid for the forward contracts, which may not be necessary if the spot rates are favorable. Therefore, option A is the best choice for hedging the exchange rate risk.

Your Firm Is a U