As the Vin’s exports tennis balls to the UK, it receives British pounds. The cheque, denominated in pounds, for last month’s exports just arrived. David normally deposits the check with his local bank and requests that the bank convert the cheque to euros at the prevailing spot rate, assuming that he did not use a forward contract to hedge this payment. David’s local bank provides foreign exchange services for many of its business customers who need to buy or sell widely traded currencies. Today, however, David decided to check the quotations of the spot rate at other banks before converting the payment into euros.

a. Do you think David will be able to find a bank that provides him with a more favorable spot rate than his local bank? Explain.

b. Do you think David’s bank is like to provide more reasonable quotations for the spot rate of the pounds if it is the only bank in town that provides foreign exchange services?

c. David is considering using a forward contract to hedge the anticipated receivables in pounds next month. His local bank quoted him a spot rate of 1.45 euros and a one-month forward rate of 1.4435 euros. Before David decides to sell pounds one month forward, he wants to be sure that the forward rate is reasonable, given the spot rate. A one-month Treasury security in Ireland currently offers a yield of 1%, while a one-month Treasury security in the UK offers a yield of 1.4%. Do you believe that the one-month forward rate is reasonable given the spot rate of 1.45 euros?

Answer rating: 100% (QA)

a Yes David may be able to find a bank that provides him with a more favourable spot rate than his l... View the full answer