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CHAPTER5THEMARKETFORFOREIGNEXCHANGE

ANSWERS&SOLUTIONSTOEND-OF-CHAPTERQUESTIONSANDPROBLEMS

QUESTIONS

1.Giveafulldefinitionofthemarketforforeignexchange.

Answer:Broadlydefined,theforeignexchange(FX)marketencompassestheconversionofpurchasingpowerfromonecurrencyintoanother,bankdepositsofforeigncurrency,theextensionofcreditdenominatedinaforeigncurrency,foreigntradefinancing,andtradinginforeigncurrencyoptionsandfuturescontracts.

2.Whatisthedifferencebetweentheretailorclientmarketandthewholesaleorinterbankmarketforforeignexchange?

Answer:Themarketforforeignexchangecanbeviewedasatwo-tiermarket.Onetieristhewholesaleorinterbankmarketandtheothertieristheretailorclientmarket.InternationalbanksprovidethecoreoftheFXmarket.Theystandwillingtobuyorsellforeigncurrencyfortheirownaccount.Theseinternationalbanksservetheirretailclients,corporationsorindividuals,inconductingforeigncommerceormakinginternationalinvestmentinfinancialassetsthatrequiresforeignexchange.Retailtransactionsaccountforonlyabout14percentofFXtrades.Theother86percentisinterbanktradesbetweeninternationalbanks,ornon-bankdealerslargeenoughtotransactintheinterbankmarket.

3.Whoarethemarketparticipantsintheforeignexchangemarket?

Answer:ThemarketparticipantsthatcomprisetheFXmarketcanbecategorizedintofivegroups:internationalbanks,bankcustomers,non-bankdealers,FXbrokers,andcentralbanks.InternationalbanksprovidethecoreoftheFXmarket.Approximately100to200banksworldwidemakeamarketinforeignexchange,i.e.,theystandwillingtobuyorsellforeigncurrencyfortheirownaccount.Theseinternationalbanksservetheirretailclients,thebankcustomers,inconductingforeigncommerceormakinginternationalinvestmentinfinancialassetsthatrequiresforeignexchange.Non-bankdealersarelargenon-bankfinancialinstitutions,suchasinvestmentbanks,mutualfunds,pensionfunds,andhedge

funds,whosesizeandfrequencyoftradesmakeitcost-effectivetoestablishtheirowndealingroomstotradedirectlyintheinterbankmarketfortheirforeignexchangeneeds.

Mostinterbanktradesarespeculativeorarbitragetransactionswheremarketparticipantsattempttocorrectlyjudgethefuturedirectionofpricemovementsinonecurrencyversusanotherorattempttoprofitfromtemporarypricediscrepanciesincurrenciesbetweencompetingdealers.

FXbrokersmatchdealerorderstobuyandsellcurrenciesforafee,butdonottakeapositionthemselves.Interbanktradersuseabrokerprimarilytodisseminateasquicklyaspossibleacurrencyquotetomanyotherdealers.

Centralbankssometimesinterveneintheforeignexchangemarketinanattempttoinfluencethepriceofitscurrencyagainstthatofamajortradingpartner,oracountrythatit“fixes”or“pegs”itscurrencyagainst.Interventionistheprocessofusingforeigncurrencyreservestobuyone’sowncurrencyinordertodecreaseitssupplyandthusincreaseitsvalueintheforeignexchangemarket,oralternatively,sellingone’sowncurrencyforforeigncurrencyinordertoincreaseitssupplyandloweritsprice.

4.Howareforeignexchangetransactionsbetweeninternationalbankssettled?

Answer:Theinterbankmarketisanetworkofcorrespondentbankingrelationships,withlargecommercialbanksmaintainingdemanddepositaccountswithoneanother,calledcorrespondentbankaccounts.Thecorrespondentbankaccountnetworkallowsfortheefficientfunctioningoftheforeignexchangemarket.Asanexampleofhowthenetworkofcorrespondentbankaccountsfacilitiesinternationalforeignexchangetransactions,consideraU.S.importerdesiringtopurchasemerchandiseinvoicedinguildersfromaDutchexporter.TheU.S.importerwillcontacthisbankandinquireabouttheexchangerate.IftheU.S.importeracceptstheofferedexchangerate,thebankwilldebittheU.S.importer’saccountforthepurchaseoftheDutchguilders.ThebankwillinstructitscorrespondentbankintheNetherlandstodebititscorrespondentbankaccounttheappropriateamountofguildersandtocredittheDutchexporter’sbankaccount.Theimporter’sbankwillthendebititsbookstooffsetthedebitofU.S.importer’saccount,reflectingthedecreaseinitscorrespondentbankaccountbalance.

5.Whatismeantbyacurrencytradingatadiscountoratapremiumintheforwardmarket?

Answer:Theforwardmarketinvolvescontractingtodayforthefuturepurchaseorsaleofforeignexchange.Theforwardpricemaybethesameasthespotprice,butusuallyitishigher(atapremium)orlower(atadiscount)thanthespotprice.

6.WhydoesmostinterbankcurrencytradingworldwideinvolvetheU.S.dollar?

Answer:Tradingincurrenciesworldwideisagainstacommoncurrencythathasinternationalappeal.ThatcurrencyhasbeentheU.S.dollarsincetheendofWorldWarII.However,theeuroandJapaneseyenhavestartedtobeusedmuchmoreasinternationalcurrenciesinrecentyears.Moreimportantly,tradingwouldbeexceedinglycumbersomeanddifficulttomanageifeachtradermadeamarketagainstallothercurrencies.

7.Banksfinditnecessarytoaccommodatetheirclients’needstobuyorsellFXforward,inmanyinstancesforhedgingpurposes.Howcanthebankeliminatethecurrencyexposureithascreatedforitselfbyaccommodatingaclient’sforwardtransaction?

Answer:Swaptransactionsprovideameansforthebanktomitigatethecurrencyexposureinaforwardtrade.Aswaptransactionisthesimultaneoussale(orpurchase)ofspotforeignexchangeagainstaforwardpurchase(orsale)ofanapproximatelyequalamountoftheforeigncurrency.Toillustrate,supposeabankcustomerwantstobuydollarsthreemonthsforwardagainstBritishpoundsterling.Thebankcanhandlethistradeforitscustomerandsimultaneouslyneutralizetheexchangerateriskinthetradebyselling(borrowed)Britishpoundsterlingspotagainstdollars.Thebankwilllendthedollarsforthreemonthsuntiltheyareneededtodeliveragainstthedollarsithassoldforward.TheBritishpoundsreceivedwillbeusedtoliquidatethesterlingloan.

8.ACAD/$banktraderiscurrentlyquotingasmallfigurebid-askof35-40,whentherestofthemarketistradingatCAD1.3436-CAD1.3441.Whatisimpliedaboutthetrader’sbeliefsbyhisprices?

Answer:ThetradermustthinktheCanadiandollarisgoingtoappreciateagainsttheU.S.dollarandthereforeheistryingtoincreasehisinventoryofCanadiandollarsbydiscouragingpurchasesofU.S.dollarsbystandingwillingtobuy$atonlyCAD1.3435/$1.00andofferingtosellfrominventoryattheslightlylowerthanmarketpriceofCAD1.3440/$1.00.

9.Whatistriangulararbitrage?Whatisaconditionthatwillgiverisetoatriangulararbitrageopportunity?

Answer:TriangulararbitrageistheprocessoftradingoutoftheU.S.dollarintoasecondcurrency,thentradingitforathirdcurrency,whichisinturntradedforU.S.dollars.Thepurposeistoearnanarbitrage

profitviatradingfromthesecondtothethirdcurrencywhenthedirectexchangebetweenthetwoisnotinalignmentwiththecrossexchangerate.

Most,butnotall,currencytransactionsgothroughthedollar.Certainbanksspecializeinmakingadirectmarketbetweennon-dollarcurrencies,pricingatanarrowerbid-askspreadthanthecross-ratespread.Nevertheless,theimpliedcross-ratebid-askquotationsimposeadisciplineonthenon-dollarmarketmakers.Iftheirdirectquotesarenotconsistentwiththecrossexchangerates,atriangulararbitrageprofitispossible.

10. Overthepastfiveyears,theexchangeratebetweenBritishpoundandU.S.dollar,$/￡,haschangedfromabout1.69toabout1.31.Wouldyouagreethatoverthisfive-yearperiodthatBritishgoodshavebecomecheaperforbuyersintheUnitedStates?

CFAGuidelineAnswer:

ThevalueoftheBritishpoundinU.S.dollarshasgonedownfromabout1.69toabout1.31.Therefore,thedollarhasappreciatedrelativetotheBritishpound,andthedollarsneededbyAmericanstopurchaseBritishgoodshavedecreased.Thus,thestatementiscorrect.

PROBLEMS

1.UsingtheAmericantermquotesfromExhibit5.7,calculateacross-ratematrixfortheeuro,Swissfranc,Japaneseyen,andtheBritishpoundsothattheresultingtriangularmatrixissimilartotheportionabovethediagonalinExhibit5.8.

Solution:BecauseweareusingtheAmericantermquotes,thecross-rateformulawewanttouseis:

S(j/k)=S($/k)/S($/j).

Thetriangularmatrixwillcontain4x(4-1)/2=6cross-ratesamongthesecurrenciesinadditiontotheirUSDexchangeratesinEuropeantermscopiedfromExhibit5.7inthefirstcolumn.

$

SF

￥

￡

Euro

0.8903

0.8918

0.00799

1.1714

Switzerland

0.9982

0.00895

1.3134

Japan

111.49

146.69

U.K

0.7600

2.UsingtheAmericantermquotesfromExhibit5.7,calculatetheone-,three-,andsix-monthforwardcross-exchangeratesbetweentheAustraliandollarandtheSwissfranc.Statetheforwardcross-ratesin“Australian”terms.

Solution:Theformulaswewanttouseare:

FN(AUD/SFr)=FN($/SFr)/FN($/AUD)

or

FN(AUD/SFr)=FN(AUD/$)/FN(SFr/$).

WewillusethetopformulathatusesAmericantermforwardexchangerates.

F1(AUD/SFr)=1.0047/.7117=1.4117

F3(AUD/SFr)=1.0104/.7125=1.4181

F6(AUD/SFr)=1.0193/.7139=1.4278

3.AforeignexchangetraderwithaU.S.banktookashortpositionof￡5,000,000whenthe$/￡exchangeratewas1.55.Subsequently,theexchangeratehaschangedto1.61.Isthismovementintheexchangerategoodfromthepointofviewofthepositiontakenbythetrader?Byhowmuchhasthebank’sliabilitychangedbecauseofthechangeintheexchangerate?

CFAGuidelineAnswer:

Theincreaseinthe$/￡exchangerateimpliesthatthepoundhasappreciatedwithrespecttothedollar.Thisisunfavorabletothetradersincethetraderhasashortpositioninpounds.

Bank’sliabilityindollarsinitiallywas5,000,000x1.55=$7,750,000

Bank’sliabilityindollarsnowis5,000,000x1.61=$8,050,000

4.Restatethefollowingone-,three-,andsix-monthoutrightforwardEuropeantermbid-askquotesinforwardpoints.

Spot 1.3431-1.3436

One-Month 1.3432-1.3442

Three-Month 1.3448-1.3463

Six-Month 1.3488-1.3508

Solution:

One-Month 01-06

Three-Month 17-27

Six-Month 57-72

5.Usingthespotandoutrightforwardquotesinproblem4,determinethecorrespondingbid-askspreadsinpoints.

Solution:

Spot 5

One-Month 10

Three-Month 15

Six-Month 20

6.UsingExhibit5.7,calculatetheone-,three-,andsix-monthforwardpremiumordiscountfortheJapaneseyenversustheU.S.dollarusingAmericantermquotations.Forsimplicity,assumeeachmonthhas30days.Whatistheinterpretationofyourresults?

Solution:Theformulawewanttouseis:

fN,JPY=[(FN($/￥)-S($/￥)/S($/￥)]x360/N

f1,JPY=[(.00899-.00897)/.00897]x360/30=.02676

f3,JPY=[(.00903-.00897)/.00897]x360/90=.02676

f6,JPY=[(.00910-.00897)/.00897]x360/180=.02899

ThepatternofforwardpremiumsindicatesthattheJapaneseyenistradingatapremiumversustheU.S.dollar.Thatis,itbecomesmoreexpensivetobuyaJapaneseyenforwardforU.S.dollars(inabsoluteandpercentageterms)thefurtherintothefutureonecontracts.

7.UsingExhibit5.7,calculatetheone-,three-,andsix-monthforwardpremiumordiscountfortheU.S.dollarversustheBritishpoundusingEuropeantermquotations.Forsimplicity,assumeeachmonthhas30days.Whatistheinterpretationofyourresults?

Solution:Theformulawewanttouseis:

fN,$=[(FN(￡/$)-S(￡/$))/S(￡/$)]x360/N

f1,$=[(.7588-.7600)/.7600]x360/30=-.01895

f3,$=[(.7565-.7600)/.7600]x360/90=-.01842

f6,$=[(.7532-.7600)/.7600]x360/180=-.01789

ThepatternofforwardpremiumsindicatesthatthedollaristradingatadiscountversustheBritishpound.Thatis,itbecomeslessexpensivetobuyadollarforwardforBritishpounds(inabsoluteandpercentageterms).However,theforwarddiscountdecreasesslightlyasonecontractsfurtherintothefuture.

8. AbankisquotingthefollowingexchangeratesagainstthedollarfortheSwissfrancandtheAustraliandollar:

SFr/$=1.5960--70

A$/$=1.7225--35

AnAustralianfirmasksthebankforanA$/SFrquote.Whatcross-ratewouldthebankquote?

CFAGuidelineAnswer:

TheSFr/A$quotationisobtainedasfollows.Inobtainingthisquotation,wekeepinmindthatSFr/A$=SFr/$/A$/$,andthattheprice(bidorask)foreachtransactionistheonethatismoreadvantageoustothebank.

TheSFr/A$bidpriceisthenumberofSFrthebankiswillingtopaytobuyoneA$.Thistransaction(buyA$—sellSFr)isequivalenttosellingSFrtobuydollars(atthebidrateof1.5960andthesellingthosedollarstobuyA$(atanaskrateof1.7235).Mathematically,thetransactionisasfollows:

bidSFr/A$=(bidSFr/$)/(askA$/$)=1.5960/1.7235=0.9260

TheSFr/A$askpriceisthenumberofSFrthebankisaskingforoneA$.Thistransaction(sellA$—buySFr)isequivalenttobuyingSFrwithdollars(attheaskrateof1.5970andthensimultaneouslypurchasingthesedollarsagainstA$(atabidrateof1.7225).Thismaybeexpressedasfollows:

askSFr/A$=(askSFr/$)/(bidA$/$)=1.5970/1.7225=0.9271

Theresultingquotationbythebankis

SFr/A$=0.9260—0.9271

9.Giventhefollowinginformation,whataretheNZD/SGDcurrencyagainstcurrencybid-askquotations?

AmericanTerms EuropeanTerms

BankQuotations Bid Ask Bid Ask

NewZealanddollar .7265 .7272 1.3751 1.3765

Singaporedollar .6135 .6140 1.6287 1.6300

Solution:Equation5.12fromthetextimpliesSb(NZD/SGD)=Sb($/SGD)xSb(NZD/$)=.6135x1.3751=.8436.Thereciprocal,1/Sb(NZD/SGD)=Sa(SGD/NZD)=1.1854.Analogously,itisimpliedthatSa(NZD/SGD)=Sa($/SGD)xSa(NZD/$)=.6140x1.3765=.8452.Thereciprocal,1/Sa(NZD/SGD)=Sb(SGD/NZD)=1.1832.Thus,theNZD/SGDbid-askspreadisNZD0.8436-NZD0.8452andtheSGD/NZDspreadisSGD1.1832-SGD1.1854.

10. DougBernardspecializesincross-ratearbitrage.Henoticesthefollowingquotes:

Swissfranc/dollar=SFr1.5971?$

Australiandollar/U.S.dollar=A$1.8215/$

Australiandollar/Swissfranc=A$1.1440/SFr

Ignoringtransactioncosts,doesDougBernardhaveanarbitrageopportunitybasedonthesequotes?Ifthereisanarbitrageopportunity,whatstepswouldhetaketomakeanarbitrageprofit,andhowwouldheprofitifhehas$1,000,000availableforthispurpose.

CFAGuidelineAnswer:

A. Theimplicitcross-ratebetweenAustraliandollarsandSwissfrancisA$/SFr=A$/$x$/SFr=(A$/$)/(SFr/$)=1.8215/1.5971=1.1405.However,thequotedcross-rateishigheratA$1.1.1440/SFr.So,triangulararbitrageispossible.

B. Inthequotedcross-rateofA$1.1440/SFr,oneSwissfrancisworthA$1.1440,whereasthecross-ratebasedonthedirectratesimpliesthatoneSwissfrancisworthA$1.1405.Thus,theSwissfrancisovervaluedrelativetotheA$inthequotedcross-rate,andDougBernard’sstrategyfortriangulararbitrageshouldbebasedonsellingSwissfrancstobuyA$asperthequotedcross-rate.Accordingly,thestepsDougBernardwouldtakeforanarbitrageprofitisasfollows:

SelldollarstogetSwissfrancs:Sell$1,000,000toget$1,000,000xSFr1.5971/$=SFr1,597,100.

SellSwissfrancstobuyAustraliandollars:SellSFr1,597,100tobuySFr1,597,100xA$1.1440/SFr=A$1,827,082.40.

SellAustraliandollarsfordollars:SellA$1,827,082.40forA$1,827,082.40/A$1.8215/$=$1,003,064.73.

Thus,yourarbitrageprofitis$1,003,064.73-$1,000,000=$3,064.73.

11. AssumeyouareatraderwithDeutscheBank.Fromthequotescreenonyourcomputerterminal,younoticethatDresdnerBankisquoting€0.7627/$1.00andCreditSuisseisofferingSFr1.1806/$1.00.YoulearnthatUBSismakingadirectmarketbetweentheSwissfrancandtheeuro,withacurrent€/SFrquoteof.6395.Showhowyoucanmakeatriangulararbitrageprofitbytradingattheseprices.(Ignorebid-askspreadsforthisproblem.)Assumeyouhave$5,000,000withwhichtoconductthearbitrage.WhathappensifyouinitiallyselldollarsforSwissfrancs?What€/SFrpricewilleliminatetriangulararbitrage?

Solution:TomakeatriangulararbitrageprofittheDeutscheBanktraderwouldsell$5,000,000toDresdnerBankat€0.7627/$1.00.Thistradewouldyield€3,813,500=$5,000,000x.7627.TheDeutscheBanktraderwouldthenselltheeurosforSwissfrancstoUnionBankofSwitzerlandatapriceof€0.6395/SFr1.00,yieldingSFr5,963,253=€3,813,500/.6395.TheDeutscheBanktraderwillreselltheSwissfrancstoCreditSuissefor$5,051,036=SFr5,963,253/1.1806,yieldingatriangulararbitrageprofitof$51,036.

IftheDeutscheBanktraderinitiallysold$5,000,000forSwissfrancs,insteadofeuros,thetradewouldyieldSFr5,903,000=$5,000,000x1.1806.TheSwissfrancswouldinturnbetradedforeurostoUBSfor€3,774,969=SFr5,903,000x.6395.TheeuroswouldberesoldtoDresdnerBankfor$4,949,481=€3,774,969/.7627,oralossof$50,519.Thus,itisnecessarytoconductthetriangulararbitrageinthecorrectorder.

TheS(€/SFr)crossexchangerateshouldbe.7627/1.1806=.6460.Thisisanequilibriumrateatwhichatriangulararbitrageprofitwillnotexist.(Thestudentcandeterminethisforhimself.)AprofitresultsfromthetriangulararbitragewhendollarsarefirstsoldforeurosbecauseSwissfrancsarepurchasedforeurosattoolowarateincomparisontotheequilibriumcross-rate,i.e.,Swissfrancsarepurchasedforonly€0.6395/SFr1.00insteadoftheno-arbitragerateof€0.6460/SFr1.00.Similarly,whendollarsarefirstsoldforSwissfrancs,anarbitragelossresultsbecauseSwissfrancsaresoldforeurosattoolowarate,resultingintoofeweuros.Thatis,eachSwissfrancissoldfor€0.6395/SFr1.00insteadofthehigherno-arbitragerateof€0.6460/SFr1.00.

12. Thecurrentspotexchangerateis$1.95/￡andthethree-monthforwardrateis$1.90/￡.Basedonyouranalysisoftheexchangerate,youareprettyconfidentthatthespotexchangeratewillbe$1.92/￡inthreemonths.Assumethatyouwouldliketobuyorsell￡1,000,000.

a. Whatactionsdoyouneedtotaketospeculateintheforwardmarket?Whatistheexpecteddollarprofitfromspeculation?

b. Whatwouldbeyourspeculativeprofitindollartermsifthespotexchangerateactuallyturnsouttobe$1.86/￡.

Solution:

a. Ifyoubelievethespotexchangeratewillbe$1.92/￡inthreemonths,youshouldbuy￡1,000,000forwardfor$1.90/￡.Yourexpectedprofitwillbe:

$20,000=￡1,000,000x($1.92-$1.90).

b. Ifthespotexchangerateactuallyturnsouttobe$1.86/￡inthreemonths,yourlossfromthelongpositionwillbe:

-$40,000=￡1,000,000x($1.86-$1.90).

13. OmniAdvisors,aninternationalpensionfundmanager,planstosellequitiesdenominatedinSwissFrancs(CHF)andpurchaseanequivalentamountofequitiesdenominatedinSouthAfricanrands(ZAR).

Omniwillrealizenetproceedsof3millionCHFattheendof30daysandwantstoeliminatetheriskthattheZARwillappreciaterelativetotheCHFduringthis30-dayperiod.ThefollowingexhibitshowscurrentexchangeratesbetweentheZAR,CHF,andtheU.S.dollar(USD).

CurrencyExchangeRates

ZAR/USD

ZAR/USD

CHF/USD

CHF/USD

Maturity

Bid

Ask

Bid

Ask

Spot

6.2681

6.2789

1.5282

1.5343

30-day

6.2538

6.2641

1.5226

1.5285

90-day

6.2104

6.2200

1.5058

1.5115

DescribethecurrencytransactionthatOmnishouldundertaketoeliminatecurrencyriskoverthe30-dayperiod.

Calculatethefollowing:

?TheCHF/ZARcross-currencyrateOmniwoulduseinvaluingtheSwissequityportfolio.

?ThecurrentvalueofOmni’sSwissequityportfolioinZAR.

?TheannualizedforwardpremiumordiscountatwhichtheZARistradingversustheCHF.

CFAGuidelineAnswer:

ToeliminatethecurrencyriskarisingfromthepossibilitythatZARwillappreciateagainsttheCHFoverthenext30-dayperiod,Omnishouldsell30-dayforwardCHFagainst30-dayforwardZARdelivery(sell30-dayforwardCHFagainstUSDandbuy30-dayforwardZARagainstUSD).

Thecalculationsareasfollows:

?Usingthecurrencycrossratesoftwoforwardforeigncurrenciesandthreecurrencies (CHF,ZAR,USD),theexchangewouldbeasfollows:

--30dayforwardCHFaresoldforUSD.Dollarsareboughtattheforwardselling priceofCHF1.5285=$1(doneatasksidebecausegoingfromcurrencyinto

dollars)

--30dayforwardZARarepurchasedforUSD.Dollarsaresimultaneouslysoldto purchaseZARattherateof6.2538=$1(doneatthebidsidebecausegoingfrom dollarsintocurrency)

--Forevery1.5285CHFheld,6.2538ZARarereceived;thusthecrosscurrencyrateis 1.5285CHF/6.2538ZAR=0.244411398.

?Atthetimeofexecutionoftheforwardcontracts,thevalueofthe3millionCHFequityportfoliowouldbe3,000,000CHF/0.244411398=12,274,386.65ZAR.

?TocalculatetheannualizedpremiumordiscountoftheZARagainsttheCHFrequirescomparisonofthespotsellingexchangeratetotheforwardsellingpriceofCHFforZAR.

Spotrate=1.5343CHF/6.2681ZAR=0.244779120

30dayforwardaskrate1.5285CHF/6.2538ZAR=0.244411398

Thepremium/discountformulais:

[(forwardrate–spotrate)/spotrate]x(360/#daycontract)=

[(0.244411398–0.24477912)/0.24477912]x(360/30)=

-1.8027126%=-1.80%discountZARtoCHF

MINICASE:SHREWSBURYHERBALPRODUCTS,LTD.

ShrewsburyHerbalProducts,locatedincentralEnglandclosetotheWelshborder,isanold-lineproducerofherbalteas,seasonings,andmedicines.ItsproductsaremarketedallovertheUnitedKingdomandinmanypartsofcontinentalEuropeaswell.

ShrewsburyHerbalgenerallyinvoicesinBritishpoundsterlingwhenitsellstoforeigncustomersinordertoguardagainstadverseexchangeratechanges.Nevertheless,ithasjustreceivedanorderfromalargewholesalerincentralFrancefor￡320,000ofitsproducts,conditionalupondeliverybeingmadeinthreemonths’timeandtheorderinvoicedineuros.

Shrewsbury’scontroller,EltonPeters,isconcernedwithwhetherthepoundwillappreciateversustheeurooverthenextthreemonths,thuseliminatingallormostoftheprofitwhentheeuroreceivableispaid.Hethinksthisisanunlikelypossibility,buthedecidestocontactthefirm’sbankerforsuggestionsabouthedgingtheexchangerateexposure.

Mr.Peterslearnsfromthebankerthatthecurrentspotexchangerateis€/￡is€1.4537,thustheinvoiceamountshouldbe€465,184.Mr.Petersalsolearnsthatthethree-monthforwardratesforthepoundandtheeuroversustheU.S.dollarare$1.8990/￡1.00and$1.3154/€1.00,respectively.Thebankerof