Currency Hedge Decision

In: Business and Management

Submitted By simg25
Words 1646
Pages 7
Stuart Graham
International Finance
Mid Term Paper
Student ID: 810110116

This case analyzes the business transaction between DC Inc (US seller) and CR Limited (UK purchaser) for 100,000 pounds. DC Inc has determined that its minimum acceptable sale price was 170,000 which therefore implied that its budget exchange rate was $1.70/pound.

The transaction risk here is that the exchange rate could fall below $1.70 resulting in a loss to DC. Inc.

This paper will analyze four options available to DC Inc to manage its currency exposure:

1. Remain Unhedged 2. Hedge in the forward market 3. Hedge in the money market 4. Hedge in the Options market

Option # 1 – Remain unhedged

The first option for DC is to accept the risk of the transaction and assume that the advisory forecast of $1.76/pound is correct.
In this instance DC can expect to receive:

|Amount in £ |Rate $/£ |$ Received in September |
| 100,000.00 |1.76 | 176,000.00 |

Although this may seem acceptable, it is not a certainty that the forecast of 1.76/pound would be correct. For example we can shock the exchange rate up and down to see varied result both positive and negative for DC.

|Amount in £ |Rate $/£ |$ Received in September |Shock |
| 100,000.00 |1.76 | 176,000.00 |None |
| 100,000.00 |1.86 | 186,000.00 |Shock Up |
| 100,000.00 |1.66 | 166,000.00 |Shock Down |

As projected a rise in the rate of dollar/pound by 10bps would be good for DC representing a dollar income of $186,000, an opposite result occurs if the rate falls 10bps to 1.66/pound. This would result in an income of $166,000, which is $4,000 below his…...

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