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XYZ Ltd, a UK firm has sold goods to a US supplier and will receive...

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Finance

XYZ Ltd, a UK firm has sold goods to a US supplier and will receive US$1O million in three months' time. The company finance director wishes to hedge against the foreign exchange risk and is considering 3 methods:

- Using the forward exchange contract

- Using the money market hedge

- Using a currency option

Annual interest rate and foreign exchange rate are given below:

US$ UK

Deposit Rate Borrowing Rate Deposit Rate Borrowing Rate

1 month 7% 10.2 % 10.75% 14.0%

3 months 7% 10.75% 14.0% 14.25%

Spot rate 1: $ 1.2625 - 1.2635

1 month forward 0.60 - 0.58 cents premium

3 months forward 1.80 - 1.75 cents premium

A 3 month currency option to sell US$10 million at an exchange rate of 1: 1.2625 1.2635 is currently costing 20,000.

Required:

Advise the company on the best method to use.

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