A US-based firm has a contract which will see it receiving GBP 750,000 in 180-day.  The firm typically does not hedge its transactions but the newly instated finance manager has touted the benefits of using the hedge and he also has experience in such transactions. The finance team has compiled the following information to assist finance manager. The current spot rate is $0.9905/£ but they forecast that that exchange rate will devalue to $1.0301/£ within the 180 days.

Barclays Bank 180-day Forward rate                         $1.0050/£

Citi Bank 180-day Forward rate                                 $0.9985/£

180-day GBP borrowing rates                                    7.00% p.a.

Firm Weighted Average Cost of Capital                    11.00%

The firm's directors are not opposed to take an uncovered position but is eager to see the results of the possible hedge options.

Required:

Use the information provided to make a hedging recommendation.                          
Why are firms reluctant to use hedging to manage its cash flows? Briefly explain two (2) reasons.

Answer rating: 100% (QA)

To make a hedging recommendation lets compare the potential outcomes of the different hedge options ... View the full answer