A United Kingdom firm is planning to hedge an import payment of USD 5 million due in 6 months (i.e. the firm will expect to pay the USD 5 million in 6 months-time).

The spot rate is 1 UK = 1.26 USD. Note: UK = UK pounds. USD = US Dollars.

The 6-month forward rate is 1 UK = 1.2670 USD. The six-month interest rate for borrowing (and lending) in the United Kingdom (UK) is 1.00% p.a. and in the United States (US) is 2.60% p.a. respectively. All interest rates are continuously compounded rates.

Required:

Explain two possible alternative options to hedge the USD payment. What is the best way for the company to hedge its future USD payment or cash outflow?

How much better off in UK pounds are you under the best option at time t = 6 months hence?

Assume the firm can borrow or lend UK pounds and / or US dollars at the interest rates quoted above and also transact at the quoted spot and forward rates.

If necessary state any other assumptions you make.

Hint: One option under a money market hedge is to .etc