1. Rana plc is a UK based company. It purchases antique furniture from specialist suppliers from many parts of the world. The procurement director has just bought US$1.8 million worth of furniture from its biggest supplier. The finance director is concerned about movements in exchange rates between the US$ and the GBP and would like to fully hedge this transaction. Payment to the supplier is expected in 60 days' time. The following details have been gathered.

The spot rate of exchange is £1 : US$ 1.3. The company can engage in a forward contract with its local bank at a rate of £1 : US$ 1.32. The two month rates of interest in the UK and the US are 0.2% and 0.4% respectively. 

 

 

REQUIRED: 

Distinguish between the three types of exchange rate risk that multinational companies may experience.

For the benefit of management at Rana plc, explain how the company may hedge the US$ transaction with (i) a forward contract; and (ii). a money market hedge, and determine which strategy may be more suitable for Rana plc. Support your explanations with suitable computations.

Compare and contrast a forward hedge to an option hedge.