Sterling & Company is a silverware manufacturer based in the town of Sevenoaks in the United Kingdom. Although Sterling exports to companies around the world, its biggest customers are in the United States. Dollar-denominated accounts (shown in italics) have been translated into pounds at the $1.50/£ exchange rate.

a. What is the value of monetary assets and monetary liabilities exposed to the dollar? What is the value of net exposed monetary assets?

b. If the dollar appreciates by 10 percent, by how much will monetary assets change in value? By how much will monetary liabilities change in value? What are the r-squares of these relations?

c. Suppose inventory is not exposed to the dollar and that the exposure of nonmonetary assets is β^$ = ρ_r,s(σ_r∕σ_s), where ρ_r,s = 0.10, σ_r = 0.20, and σ_s = 0.10. If the dollar rises in value by 10 percent, by how much are Sterling & Company’s nonmonetary assets likely to change in value? What is the r-square of this relation? Do you have much confidence in this estimate of the change in value? Why or why not?

d. Given your results above, by how much is Sterling & Company’s equity likely to change in value with a 10 percent appreciation of the dollar?

e. Sterling has a relatively large amount of dollar debt. Is this reasonable given its operating exposure from part (c)? Relate your answer to the r-square of the exposure coefficient in part (c).

f. Sterling is considering opening a manufacturing plant in the United States to hedge its dollar exposure. Discuss the advantages and disadvantages of this operating hedge of Sterling’s dollar exposure.  

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Cash in $s Cash Receivables Inventory Current assets Nonmonetary assets Total assets $ value value $30,000 20,000 Payables in $s 20,000 Payables $value value $45,000 30,000 10,000 30,000 10,000 80,000 Current liabilities 40,000 Debt in $s $90,000 60,000 Debt 20,000 80,000 Net worth 40,000 160,000 Total liabilities 160,000