Problem 7

Harmony of Manhattan, New York, is building a new factory in Malaysia. In three months, the company has to pay RM 30,000,000. The currency is Malaysian Ringgit. Harmonys weighted average cost of capital is 15%. The foreign exchange and interest quotations are the following:

Construction payment due in three months (A/P, Ringgit)	30,000,000
Present spot rate (RM/$)	4.0000
Three-month forward rate (RM/$)	4.2000
Malaysian three-month interest rate (per annum)	8.000%
U.S. dollar three-month interest rate (per annum)	4.000%
Harmonys weighted average cost of capital (WACC)	15.000%

Harmonys treasury manager, concerned about the exchange rate fluctuations, contemplates hedging its foreign exchange risk. The managers own forecast is as follows:

Expected spot rate in three-months (RM/$):
Highest expected rate (reflecting a significant devaluation)	4.8000
Expected rate	4.5000
Lowest expected rate (reflecting a strengthening of the RM)	3.8000

What realistic alternatives are available to Harmony for making payments? Which method would you select and why?