Question

An american company is commencing work in England and wants to hedge their risk of an adverse currency fluctuation. They submit a bid of (British Pounds) GBP 1.175 million and should recieve a Deposit of 10% GBP (117,500) due when accepted. The US company Planned on receiving GBP 1.0575 million April 14, 1986. To hedge this risk the US company can either sell pounds forward 90 days or secure 90 day pound loan. The loan would borrow pounds and exchange the proceeds into dollars at the spot rate. Then on April 13, would use its pound receipts to repay the loan. The loan would be 1.5% above UK prime rate.The business allowed for a profit margin of 6%. The calculations to obtain this profit margin were done on December 3, 1985.

January 14, 1986 Bid accepted:

Spot rate = USD 1.4370

Three month forward rate = USD 1.4198

Prime lending rate (UK) is 13.5%

December 3:

Spot rate = USD 1.482

Pound value at bid = 1,175,000

Q1. When can the money market hedge make sense?

Answer 1