Shrewsbury Herbal Products, Ltd$.$

Shrewsbury Herbal Products, located in Central England close to the Welsh border, is an oldline producer of herbal teas, seasonings and medicines. Their products are marketed all over

the United Kingdom and in many parts of con$$nental Europe as well.

Shrewsbury Herbal generally invoices in Bri$$sh pounds sterling when it sells to foreign

customers in order to guard against adverse exchange rate changes. Nevertheless, it has just

received an order from a large wholesaler in central France for $500,000$ of its products,

condi$$onal upon delivery being made in three months' $$me and the order invoiced in EUROS.

Shrewsbury's controller, Elton Peters, is concerned with whether the pound will appreciate

versus the euro over the next three months, thus elimina$$ng all or most of the profit when the

euro receivable is paid. He thinks this is an unlikely possibility, but he decides to contact the

firm's banker for sugges$$ons about hedging the exchange rate exposure.

Mr$.$ Peters learns from the banker that the current spot exchange rate in $/$ is $1\mathrm{.}17$; thus, the

invoice amount should be $585,000.$ Mr$.$ Peters also learns that the three$-$month forward rates

for the pound and the euro versus the US dollar are $$1\mathrm{.}26/1$ and $$1\mathrm{.}08/1,$ respec$$vely$.$ The

banker offers to set up a forward hedge for selling the euro receivable for pound sterling based

on the $/$ cross$-$forward exchange rate implicit in the forward rates against the US dollar.

QUESTIONS:

$1.$ What is the $/$ cross$-$forward exchange rate implicit in the forward rates against the US

dollar? Round off to $4$ decimal places.

$2.$ If Mr$.$ Peters agrees to do a $3-$month forward hedge contract, how much GBP will

Shewsbury receive in $3$ months?

$3.$ If Mr$.$ Peters AGREES to the $3-$month forward hedge and the FUTURE SPOT rate in $3$

months ends up to be $1\mathrm{.}1750/1,$ the how much did Mr$.$ Peters gain or lose by

hedging?

$4.$ What would you do if you were Mr$.$ Peters? To hedge or not to hedge? Why