Question
An Italian company, which uses the euro currency (EUR), purchased machinery from a U.K. company worth 850,000 British pounds (GBP). The payable is due in
An Italian company, which uses the euro currency (EUR), purchased machinery from a U.K. company worth 850,000 British pounds (GBP). The payable is due in 180 days and will be paid in British pounds. Refer to Table 2 to find the currency and market quotes collected by the treasury division of the Italian company. The market rates and the WACC in Table 2 are expressed in yearly rates (per annum). To obtain the 180-day equivalent rates, assume for simplicity that there is no compounding of interest.
Table 2:
Current spot rate (EUR per 1 GBP): EUR 1.13 / GBP
180-day forward exchange rate quote (EUR per 1 GBP): EUR 1.18 / GBP
Italian companys WACC (Weighted Average Cost of Capital) per annum: 10.00%
180-day euro investment rate per annum: 4.00%
180-day euro borrowing rate per annum: 6.00%
180-day U.K. investment rate per annum: 7.00%
180-day U.K. borrowing rate per annum: 8.00%
i) The Italian company considers dealing with its foreign exchange exposure using either a forward contract or a money market hedge. Briefly explain each hedging strategy and calculate the value of the payables in euros for the Italian company under both hedging techniques. Round your answer to two decimal points.
ii) Using the exchange rate and interest rate data in Table 2, what should the Italian companys weighted average cost of capital be so that the forward and the money market hedging techniques would have the same outcome? Round your answer to two decimal points.
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