Service

Chat Now

The Market for Foreign Exchange Middlebury Herbal Products, a United Kingdom based multi-

The Market for Foreign Exchange Middlebury Herbal Products, a United Kingdom based multi-

The Market for Foreign Exchange

Middlebury Herbal Products, a United Kingdom based multi-national corporation, is a producer of herbal teas, seasonings, and medicines. Their products are marketed in the United Kingdom and in many parts of continental Europe. Middlebury 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 France for 320,000 pounds sterling of its products, conditional upon delivery being made in 3 months’ time and the order invoiced in euros.

Middlebury’s controller, Elton Peters, is concerned with whether the pound will appreciate against the euro over the next 3 months, thus eliminating all or most of the profit when the euro receivable is paid. He thinks this 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 in euro/pounds is 1.5641; thus the invoice amount should be 500,512 euro. Mr. Peters also learns that the three-month forward rates for the pound and the euro versus the US dollar are $1.5019/pound sterling and $0.9699/euro, respectively. The bank does not provide forward contracts where euro is directly traded for sterling or sterling for euro. However, the banker offers to set up a forward hedge for Mr. Peters.

Mr. Peters also observes the following:

Euro

United Kingdom

3-month borrowing rate

2%

3.75%

3-month deposit rate

1.5%

3.25%

[Note: rates above are periodic (3 month) rates. They are not expressed as annual rates.]

If Middlebury uses a forward hedge, how many pounds sterling will it receive in 3 months?

If Middlebury uses a money market hedge, how many pounds sterling will it receive in 3 months?

Show how you calculate your answer.

 

Euro

United Kingdom

3-month borrowing rate

2%

3.75%

3-month deposit rate

1.5%

3.25%

Abhinav 30-Nov-2019

Answer (UnSolved)

question Get solution