1. Interbrew Leuven produces Leffe according to the same basic recipe adopted in 1240 when Leffe was first brewed. Leffe enjoys worldwide sales. Craft Beer Importers of Ontario specialises in importing beers from Europe. Payment of 20 million is due in six months. Craft Beer Importers is concerned with the volatility in Canadian dollar exchange rates vis--vis the euro and its adverse effect on accounts payables. Therefore, the firm decides to hedge its exposure to foreign exchange risk and examines the prospects of forward hedge and money market hedge for the payables. Relevant information is collected as follows:

• Currently prevailing spot exchange rate: C$1.5282/

• Six-month forward exchange rate: C$1.5306/

• Money market rate in Canada: 1.75% per annum for the six months

• Money market rate in the euroland: 0.75% per annum for the next six months

Required:

(a) Demonstrate an appropriate forward hedge procedure for the case and illustrate the gain and loss profile of the forward hedge.

(b) Demonstrate an appropriate money market hedge procedure for the case and illustrate the gain and loss profile of the money market hedge.

(c) What will be the gain or loss from the forward hedge and the money market hedge respectively, if the exchange rate in six months is C$1.5100/?

(d) What will be the gain or loss from the forward hedge and the money market hedge respectively, if the exchange rate in six months is C$1.5500/?

(e) Discuss which of the two hedging methods may be preferred under the circumstances, with theoretical justification and empirical results evident by this case.