Case Scenario $($B$)$

John Elton is the CFO of a multinational manufacturing company based in the UK$.$ One of his main responsibilities is to oversee the impact of exchange rate movements on his company's profitability. Elton is settling the end$-$of$-$quarter transactions and preparing interim financial reports.

The company hedges input costs using forward contracts that are priced in US dollars $($USD$)$ and Mexican pesos $($MXN$).$ Elton is expecting to receive a customer payment of JPY $225,000,000($Japanese yen$)$ that he wants to conven to pounds sterling $($GBP$).$ He gathers FX rates from a dealer at Union Jack Bank, shown in Exhibit I.

Exhibit $1$

CURRENCY PAIR SPOT EXCHANGE RATES

JPY$/$GBP

MXN$/$USD

GBP$/$EUR

USD$/$EUR

USD$/$GBP $187\mathrm{.}39187\mathrm{.}43$

$17\mathrm{.}14717\mathrm{.}330$

$0\mathrm{.}73420\mathrm{.}7344$

$1\mathrm{.}15721\mathrm{.}1576$

$1\mathrm{.}57621\mathrm{.}5766$

Elton then calls another dealer from Queen Vic Bank to get a GBP$/$MXN quote. The dealer quotes $0\mathrm{.}03660\mathrm{.}0372.$ Elton is curious whether there is an arbitrage profit to be made.

In three months, the company will receive EUR $5,000,000$ from another customer. Six months ago, the company sold EUR $5,000,000$ against the GBP using a nine$-$month forward contract at a forward rate of GBP$/$EUR $0\mathrm{.}7400.$ To mark the position to market, Elton collects the

GBP$/$EUR forward rates in Exhibit $2.$

Exhibit $2$

MATURITY FORWARD POINTS

I $-$month $3-$month

$6-$month $4\mathrm{.}404\mathrm{.}55$

$14\mathrm{.}0150$

$29\mathrm{.}030\mathrm{.}0$

Elton also asks for the current $90-$day LIBORs for the major currencies. Selected three$-$month LIBORs $($annualized$)$ are shown in Exhibit $3.$ Elton studies Exhibit $3$ and says, $"$We have the spot rate and the $3-$month forward rate for GBP$/$EUR$.$ As long as we have the GBP $3-$month LIBOR, we will be able to calculate the implied EUR $3-$month LIBOR."

Exhibit $3$

CURRENCY $3-$MONTH LIBOR

GDP

JPY

USD $0\mathrm{.}5800\%$

$0\mathrm{.}0893\%$

$0\mathrm{.}3300\%$

$(6)$ Using the quotes in Exhibit l$,$ calculate the amount ofGBP Elton will receive from selling JPY $225,000,000.[2$ marks$]$

$(7)$ Using the quotes from the dealers at Union Jack Bank and Queen Vic Bank, show how Elton could realize an arbitrage profit. $[5$ marks$]$

$(8)$ Based on Exhibits I and $2,$ what is the forward rate Elton should use to mark the forward contract position to market? $[3$ marks$]$

$(9)$ Based on Exhibit $2,$ explain whether the $3-$month EUR LIBOR is below, equal to$,$ or above the $3-$month GBP LIBOR. $[2$ marks$]$

$(10)$ Using the midpoint rate from the exchange rates in Exhibit I and the LIBOR rates in Exhibit $3,$ compute the $3-$month forward premium or discount for the USD$/$GBP$.[3$ marks$]$