Question 2

Paradise plc is a UK –based company and is expecting a pay $300,000 to its supplier in the US in three months. The finance manager has collected the following information:

Spot Rate ($ per £): 1.2820

Three months forward rate ($ per £) 1.2846

One year sterling interest rate: 4.6%

One year dollar interest rate: 5.24% 

Required:

a) Discuss the differences between transaction risk, translation risk and economic risk and explain how inflation rates can be used to forecast exchange rates.

b) Calculate the expected sterling to be paid in three months using the forward market.

c) Calculate the expected sterling to be paid in three months using the money market hedge and recommend whether a forward market hedge or a money market hedge should be used.

d) Compare and contrast different financial hedging strategies.