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

Silver purchased = 20000 ounces

Rate = USD 8.30 / ounce

US$ Payable by Royal mint = Quantity of silver purchased * rate = 20000 * 8.30 = $ 166,000.

a-1

If Royal mint takes a chance at the spot rate, the transaction will be settled at spot rate in six months time i.e.at $1.7915/ Pound.

Outflow in Pound= amount payable in $/ spot exchange in 6 months time = 166000/ 1.7915 = Pound 92,659.78

= Pound 92,660 (approx.).

a-2

If Royal mint takes a forward contract, transaction will be settled at 180 day forward rate i.e. $ 1.7863/ Pound

Outflow in Pound= amount payable in $/ 180 days forward rate = 166000/ 1.7863 = Pound 92,929.52

= Pound 92, 930 (approx.)

a-3

If Royal mint buys a money market hedge where it has $ 166000 payable after 180 days, it will buy the present value of $ 166000 and invest it at 1.15% in USA.

To buy the dollars, it will convert pound into dollars at current spot rate of $ 1.8127/Pound, and the pound required will be borrowed by Royal mint at 4.70%

Hence, PV of $ outflow= 166000/1.0115 =$ 164,112.70

Pounds required to buy dollars as calculated above = dollars required/ spot exchange rate=164112.70/1.8127 = Pound 90,534.95

Pounds required will be borrowed at 4.70 %, hence outflow after 180 days of pound =Borrowings ( 1+ Interest Rate /100)

= 90534.95 (1+0.047) = Pounds 94,790.09=Pounds 94,790 (approx.)