R Co is a manufacturing company based in the UK. All manufacturing previously took place in the UK but two years ago the company found that it would be much more profitable if its factory was based in the US.

A factory was built costing £9m which was financed by reserves and a 7-year 4% foreign bond denominated in dollars. The amount of funds raised at the time was £5m when the prevailing spot rate was $1.60 per £. Each bond in issue has a par value of $1,000. The rate of interest on dollar denominated bonds with a similar risk profile is 5%. The annual interest payment due on the bond is payable in 6 months time.

Required:

1. Calculate the market value in dollars of the foreign bond.

2. Advise the company, using the information provided below and showing relevant calculations, whether a money market hedge or a forward contract would be better to minimise the company’s exposure to exchange rate risk with regards to the interest payment to be made on the bond in one year’s time. Include in your answer a brief explanation of how a money market hedge works with regard to paying cash in a foreign currency.
3. 

Spot ($ per ) 1.62 1.75 6 month forward (S per ) 1.64 - 1.77 Annual Interest rates for 6 month borrowing and lending : UK Borrowing Deposit 6% 4% US S Borrowing Deposit 9% 8%