An exporter in the UK has invoiced a customer in the USA the sum of $300,000 receivable in one year's time.

He has under consideration two methods of hedging his exchange risk:

(a) By borrowing an appropriate amount now for one year, converting the amount into sterling, and repaying the loan out of the eventual receipts.

(b) By entering into a 12-month forward exchange contract to sell the $300,000

 

The sterling-US dollar spot rate is 1.8190-1.8402.

The 12-months forward rate of dollars against sterling is 1.7703-1.7915. Interest rates for 12 months are USA 6.65% UK 9.25%.

 

You are required to calculate the net proceeds in sterling under each alternative and suggest which is the better alternative.

Answer rating: 100% (QA)

To compare the two methods of hedging the exchange risk we need to calculate the cost of each option ... View the full answer