:SHREWSBURY HERBAL PRODUCTS, LTD.

Shrewsbury Herbal Products, located in central England close to the Welsh border, is an old-line producer of herbal teas, seasonings, and medicines.Its products are marketed all over the United Kingdom and in many parts of continental Europe as well.

Shrewsbury Herbal generally invoices in British pound sterling when it sells to foreign customers in order to guard against adverse exchange rate changes.Nevertheless, it has just received an order from a large wholesaler in central France for 320,000 of its products, conditional upon delivery being made in three months' time and the order invoiced in euros.

Shrewsbury's controller, Elton Peters, is concerned with whether the pound will appreciate versus the euro over the next three months, thus eliminating all or most of the profit when the euro receivable is paid.He thinks this is an unlikely possibility, but he decides to contact the firm's banker for suggestions about hedging the exchange rate exposure.

Mr. Peters learns from the banker that the current spot exchange rate is / is 1.4537, thus the invoice amount should be 465,184.Mr. Peters also learns that the three-month forward rates for the pound and the euro versus the U.S. dollar are $1.8990/1.00 and $1.3154/1.00, respectively.The banker offers to set up a forward hedge for selling the euro receivable for pound sterling based on the / forward cross-exchange rate implicit in the forward rates against the dollar.

Question:

What would you do if you were Mr. Peters?

Would you recommend that Mr. Peters hedge its 465,184 exposure using a forward contract?

Determine whether the euro, given the three-month forward rates, is trading at a forward premium or discount to the pound? What is the forward premium or discount as an annualized rate? At a forward premium, would you recommend the forward hedge? At a forward discount, would you still recommend the forward hedge?

How would you use a forward contract to set up a forward hedge for Mr. Peters? What would be the expected pound proceeds from a forward hedge?