Case Study
The UK Treasurer of A H Corporation expects to receive a payment for wool exports to a customer in Munich in 3 months time. Her marketing department has sold 1000 “ 100 % Wool suits” for a delivered price of 250 Euros each. In the financial times on 10th June she reads the following:
Spot FX Rate 0.850(Euro/Pound)
3 month Forward FX Rate o.853(Euro/Pound
Pound 3 month interest rate
Annualised r=5(9/16) (=0.055625)
Euro 3 month interest rate
Annualised r=7(1/16) (=0.07625)
Questions
a) Explain using the above data how the Treasurer can hedge her receipts in Euros by
i) taking forward cover
ii) taking money market cover.
b) What would be the amount of Sterling received if the Treasurer took an uncovered (open) position and the spot rate in 3 months time are as follows:
i) 0.653(Euro/Pound)
ii) 0.658(Euro/Pound)
iii) 0.640(Euro/Pound)
In each case, compare the hedged outcome with the uncovered outcome.
c) Does the set of interest and exchange rates prevailing on 15th June conform with covered interest parity? If not, explain how equilibrium will be established in the relevant markets...