8. Mini-Case JB Dollar Exposure

JB Feeds, a US-based feed firm, sold an entire cargo shipment of bird feed to its primary dealer in the U.K., Birds-R-Us. The shipment is set to arrive in three months and has billed 20 million payable due in three-months. Recent political changes and economic concerns are troubling to management at JB so they assigned JBs treasury department to analyze the exchange rate risks.

Current spot exchange rate : 1.467 / $

3-month forward exchange rate : 1.5345 / $

3-month Put Premium on U.K. pounds: $ 0.02 /

3-month Put Option on U.S. dollars Strike Price: $ 0.68 /

Current 3-month U.S. interest rate: 2.7%

Current 3-month U.K. interest rate: 3.2%

(a) Compute the guaranteed dollar proceeds from the sale if hedge using a forward contract.

(b) If the treasurer decides to hedge using money market instruments, what action does JB Feeds need to take? What would be the guaranteed dollar proceeds from the sale in this case?

(c) If JB Feeds decides to hedge using put options on pounds, what would be the expected dollar proceeds from the sale? Assume that JBs treasurer regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.

(d) At what future spot exchange rate do you think JB Feeds will be indifferent between the option and money market hedge?

(e) At what future spot exchange rate do you think JB Feeds will be indifferent between the option and the forward?