Response Week 2 Discussion 1: Chee (she/her/hers) Mini Case Facts: Shrewsbury Herbal Products is a herbal tea, seasonings & medicine producer in England that usually invoices its customer in British Pound to guard against unfavorable exchange rate impact. The company received a large order of £320,000 from a European wholesaler, with a condition to invoice the order in euros to be paid upon delivery in three months. Mr. Peters, the controller of Shrewsbury, learned the following rates from the bank and needs to decide the best options to hedge against FX exposure: Invoice price: £320,000 Current Spot Exchange Rate: €1.4537 Three-month Forward Rates: $1.8990/£1.00 and $1.3154/€1.00 (1) Spot Exchange Rate: The spot exchange rate, also known as the spot rate, is the current price that can be traded immediately or “on the spot” (Nickolas, 2022). The current spot exchange rate is €1.4537, and the invoice price would be €465,184 (£320,000 x €1.4537) if the supplier paid the order today. However, since the requirement is to be paid in three months, the daily fluctuation of the spot exchange rate would expose the company to foreign exchange risks. (2) Forward Exchange Rate: The forward exchange rate, also known as the forward rate, refers to the instrument’s price in the future(Nickolas, 2022). In this case, the Three-month forward exchange rate will be the price in three months. Calculation: $1.8990/£1.00 = $1.3154/€1.00 €/£ = $1.8990 / $1.3154 €/£ = 1.4437 €465,184 / 1.4437 = £322,216.53 Since the invoice amount for the order is €465,184, using the forward exchange rate can lock in the price of £322,216.53. If I were Mr. Peter, I would accept the banker’s offer to set up a forward hedge for selling the euro receivable for pound sterling based on the €/£ forward cross-exchange rate implicit in the forward rates against the dollar. Shrewsbury would invoice and receive €465,184 from the wholesaler in three-month and could end up receiving £322,216.53. If Mr. Peter uses the spot exchange rate, the company is exposed to the risk of receiving less than £320,000 if the euro is trading at a discount three-month later. -Nicole Reference: Nickolas, S. (2022, March 20). Forward Rate vs. Spot Rate: What’s the Difference? Investopedia. https://www.investopedia.com/ask/answers/042315/what-difference-between-forward-rate-and-spot-rate.asp
