Sterling 521/32 – 421/32
Source: Financial Time, 2nd March 2001
Three alternatives could be provided for the UK exporter.
l Do Nothing:
Due to the prediction of this article, the euro is premium to the sterling and the dollar. If the UK exporter has not done anything and the prediction is correct, the firm would not get the loss from the French receipt. However, there would be a risk if the prediction were wrong, the firm would lose the income as a result of the devaluation of the euro.
l Hedge on Forward Market:
The spot receives of payment is 125,000= 79,900. If the French payment is covered by forward contract, the income becomes: 125,000= 80,050. In such a case, the UK firm would get 150 gain. This is better than the current spot rate. Furthermore, if the spot rate in three months is higher than 0.6404. The gain from the payment would be less than the spot market due to the forward contract is a fixed cash flow.
l Hedge on Future Market:
The UK exporter could sell an 125,000 currency contract for June delivery at the rate of 0.6407/ . The income becomes: 125,000= 80,087.5. Hence, the UK exporter would get 187.5 gain.
l Hedge on Option Market:
The UK exporter could buy three 31,250 contracts for June delivery at strike price of 1.555/ , which costs 145,781. And the premium cost would be 0.0265+3+31,250= 2,484, while it equals 1,588. Due to the payment of 125,000, the difference between the payment and the option contracts would be 20,781, which could be covered by forward contract as 13,308. So the total cost of the options would be 14,896, while the total gain would be 93,750. The income becomes 78,854. Hence, the UK exporter would get 1,046 loss.
l Hedge on Borrowing/Lending Currency Market
The UK exporter could borrow 123,523 in the market at the interest rate of (425/32)/4=1.1953%, which would be 125,000 in three months. Then it could convert into the pound at the spot rate, which equals 78,956. Depositing the pound at the interest rate of (421/32)/4=1.1640%, it would get 79,875 in three months. Therefore, the UK exporter would get 25 loss
In conclusion, the solution of hedging on the Future market would be the best way to the UK exporter, which gives the biggest profit. However, those solutions would not only the choices to the UK exporter. Furthermore, the firm could other derivatives as alternatives. Nonetheless, the foreign exchange market is so uncertain that being flexible is important to the firms no matter what strategy they use.
5. Summary
Few economic predictions have caught the behaviour of the euro s depreciation in its first 2 years. Whatever the causes of the euro s weakness, it is likely to see the euro has been gaining its value. However, the foreign exchange market is so uncertain that it could not be easy to predict the trend of the euro in the future. Therefore, other political issues could also influence this trend. As a result, either British firms or European firms have confronted this devaluation to take the risks of gains or losses. The question to them is how to manage those exposures. In summary, the choices are variety to the firms, and in the real financial world, no one-way is the best way.
References:
Buckley, A., 2000. Multinational Finance, 4th Edition. Essex: Prentice Hall
Demirag, I. and Goddard, S., 1994. Financial Management for International Business. Berkshire: McGraw-Hill
Johnson, C., 1996. In with the Euro, Out with the Pound. London: Penguin Books
Healey, N., 2000. The Euro at 20 Months: What Have We Learnt, Teaching Business & Economics, 4:3, 14-21.
Hill, C.W.L., 2000. International Business: Competing in the Global Marketplace: Postscript 2001, 3rd Edition. New York: Irwin/McGraw-Hill
Holland, J., 1993. International Financial Management, 2nd Edition. Oxford: Blackwell
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