Question
Stoneleigh Limited, a UK manufacturing company, has just signed a contract on 1st June 2018 to import $1,000,000 of raw materials from a US company.
Stoneleigh Limited, a UK manufacturing company, has just signed a contract on 1st June 2018 to import $1,000,000 of raw materials from a US company. The payment is due in three months time. The board of Stoneleigh Limited expect a steep depreciation of Sterling against $, hence they are considering two alternative ways to hedge their exposure. 1) A forward hedge 2) A futures hedge Market Data at 1st June 2018: Exchange rates: Spot $1.30/ 3-month Forward $1.28/ Currency futures: CME 62,500 September 2018 Contract (cash-settled): $1.26/ Interest rates (borrowing and lending): UK 4% per annum US 2% per annum US 2% per annum
Required: a) Evaluate the outcome of the two alternative hedging methods in 3 months time if exchange rates have moved to: i) $1.24/ iii) $1.36/
Your answer should include both a numerical and a written summary and evaluation.
b) The companys financial manager also proposes the use of money market hedging, i.e. a synthetic forward.
i) Explain how the company would use a money market hedge based on the above market data.
ii) Calculate the effective exchange rate and evaluate the outcome against your answer in a). 3
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