Mini Case 1: SHREWSBURY HERBAL PRODUCTS, LTD

Shrewsbury Herbal Products, located in central England close to the Welsh border, is an old- line producer of herbal teas, seasonings, and medicines. Its products are marketed all over the United Kingdom and in many parts of continental Europe as well.

Shrewsbury Herbal generally invoices in British pound sterling when it sells to foreign customers in order to guard against adverse exchange rate changes. Nevertheless, it has just received an order from a large wholesaler in central France for 320,000 of its products, conditional upon delivery being made in three months time, and the client insists that the order should be invoiced in euros based on the current spot rate (they dont want to take the FX risk at all).

Shrewsburys controller, Elton Peters, is concerned with whether the pound will appreciate versus the euro over the next three months, thus eliminating all or most of the profit when the euro receivable is paid (Profit percentage rate for this product is roughly 20%). He thinks this is a likely risk, so he decides to contact the firms banker for suggestions about hedging the exchange rate exposure.

Mr. Peters learns from the banker that the current spot exchange rate is S(/) = 1.4537/. Mr. Peters also learns that the three-month forward rates for the pound and the euro versus the U.S. dollar are $1.8990/1.00 and $1.3154/1.00, respectively. The banker offers to set up a forward hedge for selling the euro receivable for pound sterling based on the / forward cross- exchange rate implicit in the forward rates against the dollar.

1. What is the exchange rate that would eliminate all the profit? Do you think it is likely or not?

2. What is the profit if British pounds appreciate by 10% when the payment happens?

3. What would you do to hedge if you were Mr. Peters? According to the information above, what will be your total proceeds in terms of British pounds after hedge? Is it higher or lower than the original price? Why?

4. After negotiation, the client agrees that the order could be invoiced either in euro according to the spot rate, or in directly. With all the information, how would you invoice your client?