XYZ Ltd, a UK firm has bought goods from a US supplier and must pay US $ 4 million in 3 months time. The company finance director wishes to hedge against the foreign exchange risk and is considering 3 methods:

• Using the forward exchange contract
• Using the money market hedge
• Using a lead payments

Annual interest rate and foreign exchange rate are given below:

US $ UK

Deposit Rate Borrowing Rate Deposit Rate Borrowing Rate

1 month 7% 10.25% 10.75% 14.0%

3mnths 7% 10.75% 4.0% 4.25%

Spot rate 1: $ 1.8625 1.8635

1 month forward 0.60 0.58 cents premium

3 months forward 1.80 1.75 cents premium

Required

Advise the company on the best method to use.