The current spot exchange rate is 1.5625/ The 3 month forward premium on the is 0.0015

The current interest rates per annum are:

Borrowing rate 3.20% 4.00% Deposit rate 2.80% 3.60%

Rutini Ltd is a small manufacturing company which has recently completed a major contract in Europe, as a result of which it will receive 5m in 3 months' time. The company's directors are worried that the will weaken relative to and hence adversely affect the company's cash flows. A number of possible approaches have been suggested to deal with the foreign exchange exposure.

Required:

For (a) to (d), calculate the pay off in in 3 months for two different scenarios: (i) where the spot rate in 3 months time is 1.50/ (ii) where the spot rate in 3 months time is 1.70/

(N.B. Use both spot rates in the following calculations only where relevant.)

1. (a) Convert the 5m at the two different spot rates prevailing in 3 months' time. [10 marks]
2. (b) Use the forward foreign exchange market to sell 5m at today's 3 month forward rate. [20 marks]
3. (c) Buy today a 3 month 5m put option at an exercise price equal to the 3 month forward rate. The option premium will be 125,000, which will be paid from the company's surplus cash currently held in a bank deposit account. [20 marks]
4. (d) Convert to at the spot rate today. Finance this transaction by taking out a loan that will be completely repaid by the 5m receivable in 3 months. You will invest the proceeds in an interest-bearing bank account. [20 marks]
5. (e) What do you suggest Rutini's financial officer should do? In your answer, briefly explain some of the advantages and disadvantages of the methods employed in (a) to (d).