An American importer is due to pay GBP 1,000,000 in three months to a British
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An American importer is due to pay GBP 1,000,000 in three months to a British

Problem 1

An American importer is due to pay GBP 1,000,000 in three months to a British exporter. The following information is available:

Spot exchange rate (USD/GBP)                         1.4150

Three month forward rate (USD/GBP)             1.4135

Three month interest rate in US                  4.0% per annum

Three month interest rate in UK                  4.8% per annum

(i) Calculate the USD value of payables under a forward market hedge.

(ii) Calculate the USD value of the payables under a money market hedge. In doing so, clearly outline the steps required to perform the money market hedge.

(iii) Assuming that uncovered interest parity holds, how much would the importer expect to pay if the position remains unhedged?

Hint
Accounts & FinanceForward market hedge: A hedge which involves the use of foreign exchange forwards i.e. FX forwards. It also consists of the outright purchase of the currency at a forward exchange rate. Also, the hedge is affected by the interest rates in the two countries whose currencies are usually involved and the spot exchange rate between the two other currencies....

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