Question

Royal Minty of Britain has purchased 20,000 ounces of silver from Silver Products at US$8.30, payable in 180 days. The current spot rate is 1.8127 ($US/£) and the 180-day forward is 1.7863. The CEO at Royal Minty suggests that the spot rate in six months time will be 1.7915.

Interest rates in Britain are currently 4.70 percent for 180 days and 1.15 percent in the United States.

a-1. Calculate the receipts if Royal Minty takes a chance on the spot rate. (Round the final answer to the nearest whole pound.)

Receipts           £

  

a-2. Calculate the receipts if Royal Minty books a forward contract. (Round the final answer to the nearest whole pound.)

Receipts           £

    

a-3. Calculate the receipts if Royal Minty buys a money market hedge. (Round intermediate calculations and the final answer to the nearest whole pound.)

Receipts           £   

Answer 1

Payment to be made by Royal Minty in 180 days = Ounces x rate per ounce of silver

                                                                              = 20000 x $8.30 = $166,000

a-1

Expected rate in 6 months = $1.7915/£

Expected payment in 6 months on the expected spot rate = $166,000/1.7915 = £92659.78

a-2

If Royal Minty books a forward contract. He will pay on the forward rate i.e. $1.7863/£

Expected payment on forward contract after 6 months = $166,000/1.7863 = £92929.52

a-3

Money Market Hedge = Borrow £, convert to $, invest $, repay £ loan in 6 months

Amount of $ to be invested = $166,000/(1+ Interest rate for 6 months)

Interest rate for 6 months = 1.15% x 6/12 = 0.575%

Amount to be invested = $166,000/(1+0.575%)

                                     = $165050.96

Amount of £ needed to invest $165,050.96 = $165,050.96/Current $/£

                                                                     = $165,050.96/1.8127

                                                                     = £91,052.55

Interest and principal on Loan of £91,052.55 = (91,052.55 x 4.70% x 6/12) + 91052.55

                                                                       = £93192.28

Total Payment by royal minty after 6 months on money market hedge is £93,192.28

Note - It is assumed that rate for 180 days is given as annual rate of interest.