Question

Royal Minty of Britain has purchased 20,000 ounces of silver from Silver Products at US$8.30, payable in 180 days. The current spot rate is 1.8127 ($US/£) and the 180-day forward is 1.7863. The CEO at Royal Minty suggests that the spot rate in six months time will be 1.7915.

Interest rates in Britain are currently 4.70 percent for 180 days and 1.15 percent in the United States.

a-1. Calculate the receipts if Royal Minty takes a chance on the spot rate. (Round the final answer to the nearest whole pound.)

Receipts           £

a-2. Calculate the receipts if Royal Minty books a forward contract. (Round the final answer to the nearest whole pound.)

Receipts           £

a-3. Calculate the receipts if Royal Minty buys a money market hedge. (Round intermediate calculations and the final answer to the nearest whole pound.)

Receipts           £

Answer 1

(a) Amount of Silver Purchased = 20000 ounces, $ Price per ounce = $ 8.3, Payable Tenure = 180 days, 180-Day Spot Rate = $ 1.7915 / £

Total $ Payable = 20000 x 8.3 = $ 166000

Total £ Payable = 166000 / 1.7915 = £ 92659.78 ~ £ 92660

(b) 180-Day Forward Rate = $ 1.7863 / £

Total $ Payable = $ 166000

Total £ Payable = 166000 / 1,7863 = £ 92929.519 ~ $ 92930

(c) US Interest Rate = 1.15 % and British Interest Rate = 4.7 %

A money market hedge will be implemented as described below:

- Total $ Payable = $ 166000

- Let the prevailing conversion exchange rate be $ E / £

- Equivalent £ Payable = 166000 / E

- Borrow an amount equal to the Present Value of the equivalent £ payable = [166000/E] x [1/(1.047)]

- Convert £ borrowing into $ at the current spot rate of $ 1.8127 / £ to yield = [166000 / E] x [1/(1.047] x 1.8127 $

- Invest this converted $ borrowing at the US Interest Rate to yield [166000 / E] x [1/(1.047] x 1.8127 x 1.0115. This $ investment yield will equal the total $ payable of $ 166000 and be used to pay off Silver Products.

Therefore. [166000 / E] x [1/(1.047] x 1.8127 x 1.0115 = 166000

E = (1.8127 x 1.0115) / 1.047 = $ 1.7512 /  £

Total  £ Payables = 166000 / 1.7512 =  £ 94790.09267 ~  £ 94790

- Convert