(a)A U.K manufacturing firm is having a tender to supply machineries to Kenya. The tender conditions state that payment will be made in Kenyan Shillings in 12 months from now. The company is unsure as to what price to tender, the marginal cost of producing the machine at that time is estimated to be 1 and a 20% make-up is normal for the company.

Spot Exchange rateKES13620/1 No forward rate exists for 12 months' time.

Annual inflation rates: U.K= 5% Kenya= 12%.

Annual interest rates available to machine manufacturer: Borrowing: U.K =3% Kenya=14%; Lending: U.K= 2% Kenya= 6%

Required:

(i)Explain how the company can use the money market to hedge against foreign exchange risk. (3 marks)

(ii)If the company enters into a forward contract of KES 137.25/1, 12 months from now, determine potential gain or loss from the contract. (3 marks