A sterling-based U.K. manufacturer must pay a U.S. firm $100,000 for some goods it has imported....

  

Transcribed Image Text:

A sterling-based U.K. manufacturer must pay a U.S. firm $100,000 for some goods it has imported. The payment is due 90 days from today. Suppose the spot FX rate in U.S. dollars for British pounds is $1.27 ($1.27-1) while the 3-month forward FX rate is $1.26. In addition, suppose 3 month deposit rates in the U.S. equal 5%; 3-month deposit rates in the U.K. equal 8%. 1. Assuming the U.K. firm does not want to be exposed to the risk of a fluctuating dollar, it can a) sell pounds forward today at the 3-month price of $1.26 or b) convert pounds today at the spot rate of $1.27 and hold U.S. dollars for three months. Which is the better alternative and by how much? 2. What is the fair 3-month forward price for pounds assuming a spot rate of $1.27 and the deposit rates shown above? A sterling-based U.K. manufacturer must pay a U.S. firm $100,000 for some goods it has imported. The payment is due 90 days from today. Suppose the spot FX rate in U.S. dollars for British pounds is $1.27 ($1.27-1) while the 3-month forward FX rate is $1.26. In addition, suppose 3 month deposit rates in the U.S. equal 5%; 3-month deposit rates in the U.K. equal 8%. 1. Assuming the U.K. firm does not want to be exposed to the risk of a fluctuating dollar, it can a) sell pounds forward today at the 3-month price of $1.26 or b) convert pounds today at the spot rate of $1.27 and hold U.S. dollars for three months. Which is the better alternative and by how much? 2. What is the fair 3-month forward price for pounds assuming a spot rate of $1.27 and the deposit rates shown above?