A U.S. corporate treasurer will receive a 2 million payment in 30 days from a British customer. The treasurer has no strong opinion about the direction or magnitude of changes in the sterling spot rate, but would like to eliminate the uncertainty surrounding such movements. Within the context of the rates shown in Exhibits 1 and 3, what options are available to the treasurer for hedging the foreign exchange risk associated with the sterling payment? What is the expected cost (expressed as an annualized percentage) of each alternative? Which alternative should the treasurer pursue? How would your answers to the above questions change if the treasurer believed very strongly that sterling would trade at $1.45?
Exhibit l Spot and Forward Exchange Rates Spot 1 Month 3 Months 6 Months 12 Months Currency Sterlinga 1.4890/00 55/52 160/156 302/289 560/523 Deutsche mark 2.0310/20 22/18 64/54 128/105 277/228 French Franc 6.6575/625 73/86 263/296 505/590 1194/1351 Yen 154.20/30 8/6 33/27 75/62 164/137 SDR 1.2141/43 5/3 12/8 18/11 24/12 au.S. dollars per unit of currency. Exhibit 2 Cross-Spot Exchange Rates DM FF Yen DM .3050/51 1.3169/71 FF 3.2779/88 4.3365/84 Yen 75.9232/350 / 23.1595/618 aQuotes should be interpreted as units of the currency represented in the left-hand column per unit of currency shown in the top row. Quotes for the DM/yen and FF/yen are expressed in units per 100 yen. Exhibit 3 Eurocurrency Interest Rates 1 Month 3 Months 6 Months 12 Months Currency U.S. Dollar 5.6875-5.8125 5.5000-5.6250 5.5000-5.6250 5.6250-5.7500 Sterling 10.0625-10.1875 9.8750-9.9375 9.6875-9.7500 9.6250-9.7500 Deutsche mark 4.4375-4.5625 4.3125-4.4375 4.3125-4.4375 4.3125-4.4375 French Franc 7.1250-7.2500 7.1875-7.3125 7.1875-7.3125 7.2500-7.3750 Yen 5.1250-5.1875 4.7500-4.8125 4.6250-4.6875 4.6250-4.6875 SDR 5.9375-6.0625 5.8125-5.9375 5.7500-5.8750 5.8125-5.9375 Exhibit l Spot and Forward Exchange Rates Spot 1 Month 3 Months 6 Months 12 Months Currency Sterlinga 1.4890/00 55/52 160/156 302/289 560/523 Deutsche mark 2.0310/20 22/18 64/54 128/105 277/228 French Franc 6.6575/625 73/86 263/296 505/590 1194/1351 Yen 154.20/30 8/6 33/27 75/62 164/137 SDR 1.2141/43 5/3 12/8 18/11 24/12 au.S. dollars per unit of currency. Exhibit 2 Cross-Spot Exchange Rates DM FF Yen DM .3050/51 1.3169/71 FF 3.2779/88 4.3365/84 Yen 75.9232/350 / 23.1595/618 aQuotes should be interpreted as units of the currency represented in the left-hand column per unit of currency shown in the top row. Quotes for the DM/yen and FF/yen are expressed in units per 100 yen. Exhibit 3 Eurocurrency Interest Rates 1 Month 3 Months 6 Months 12 Months Currency U.S. Dollar 5.6875-5.8125 5.5000-5.6250 5.5000-5.6250 5.6250-5.7500 Sterling 10.0625-10.1875 9.8750-9.9375 9.6875-9.7500 9.6250-9.7500 Deutsche mark 4.4375-4.5625 4.3125-4.4375 4.3125-4.4375 4.3125-4.4375 French Franc 7.1250-7.2500 7.1875-7.3125 7.1875-7.3125 7.2500-7.3750 Yen 5.1250-5.1875 4.7500-4.8125 4.6250-4.6875 4.6250-4.6875 SDR 5.9375-6.0625 5.8125-5.9375 5.7500-5.8750 5.8125-5.9375
