Should We Dance the Irish Jig in Belfast?

San Antonio Boot Company. San Antonio Boot Company of San Antonio, Texas, has received an order for 200,000 pairs of western-cut boots and Ropers from TESCO, of Great Britain, payment to be in British pounds sterling. The boots will be shipped to TESCO under the terms of a letter of credit issued by the Bank of England on behalf of TESCO. The letter of credit specifies that the face value of the shipment, 20,000,000, will be paid according to the following terms after the Bank of England accepts a time draft drawn in accordance with the terms of the letter of credit.

Terms: 50% Down-payment at the Spot Rate

50% in 180 Days.

The current discount rate in London on 180-day bankers acceptances is 7% per annum, and TESCOs weighted average cost of capital is 7% per annum. The commission for selling a bankers acceptance in the discount market is 1.05% of the face amount.

(A)Would the San Antonio Boot Company gain by holding the acceptance to

maturity as compared to discounting the bankers acceptance at once?

(a) Hold

2. Sell

(B)What is the cost to hedge in each of the following techniques?

(1)Forward Hedge:

(a) $650,000 (b) $660,000 (c) $675,000 (d) $677,000

(2) Money Market Hedge:

(a) $554,786 (b) $557,534 (c) $563,892 (d) $566,890

(3) Options Hedge:

(a) $602,870 (b) $604,000 (c) $604,340 (d) $605,123

(4) Based on the above calculations, which technique would you use?

(a) Forward Hedge (b) Money Market Hedge (c) Option Hedge

(C) Assume that Great Britain charges a duty of 10% on shoes imported into the United Kingdom from the US. San Antonio Boot Co. in the previous question discovers that it can manufacture boots in Belfast in Northern Ireland and import them into Great Britain free of any import duty. Northern Ireland uses the Sterling Pound as its currency.

Despite the added 10% surcharge, suppose that the Belfast facility could produce the following free cash flows in millions of Pounds Sterling ():

Year: 0 1 2 3 4 5

Cash Flows (million ) -8.5 1.5 3.5 2.0 1.0 4.5

The nominal interest rate in the US is 4% (30-year T-Bond) while the rate in the UK is 6% (30-year Sovereign). The current Spot Rate is: 0.6410/$. The 180-day Forward Rate is 0.6474/$. UK lending rates are 7.5%. The 180 day strike price for the Put Option to sell Sterling is: $1.5574/ with a 0.5 cent premium per Sterling Pound. What would be the dollar($) Net Present Value for these projected sterling cash flows?

1. -$1.454367 (b) +$1.46896 (c) +$1.546949 (d) -$1.60656

2. Based on the NPV, should the SA Boot company go to Northern Ireland and make the boots or export them from the San Antonio?

(1) Export

(2) Foreign Direct Investment in N. Ireland