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Eliminate the foreign exchange risk of transaction

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Suppose you own a London Cakes Company and you recently started to export your cakes to the US. You expect to receive $700,000 in 180 days. Assume that the USD p.a. interest rate is 10% and the GBP p.a. interest rate is 7%. The spot rate is GBP/USD 1.4945 and the six-month forward rate is GBP/USD 1.4802.

i. Describe the nature and extent of your foreign exchange risk.

ii. Descrbe the two ways that could eliminate the foreign exchange risk of this transaction.

iii. Show which of the two methods in (ii) is superior.

iv. Assuming that the GBP interest rate and exchange rates are correct, determine the USD interest rate that would make you indifferent betwwen these two alternative hedging methods.

Reference no: EM132780596

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