Question

Jaguar manufactures their S-type sedan in the United Kingdom for a cost of £22,500 and sells it in the UK with a 20% margin for a price of £27,000. Today, these cars are available in the United States for a price of $44,010. Jaguar is committed to keeping the U.S. price at $44,010 for the next nine months. Assume the UK pound is expected to appreciate against the U.S. dollar to an exchange rate of $1.85/£ over the next nine months.

a. If Jaguar has not hedged against currency changes, what is the amount in pounds the company will receive at the new exchange rate? What kind of effect will this change have on their profitability?

b. What recommendation would you make to Jaguar on how to mitigate this risk?

Answer 1

a. The company will receive 44,010/1.85 = 23,789.1891891892 pounds

The profits decrease because with appreciating pounds, for every dollar, the UK firm gets fewer pounds

Appreciating pounds implies depreciating U.S. dollar, which the UK firm definitely does not want as it takes a hit on their profits in pounds.

b. In order to mitigate the risk, the UK firm could enter a futures contract to sell U.S. dollar, there by fixing a exchange rate today for the future transaction.

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