Hedge Decision on a Project Carlotto Co. (a U.S. firm) will definitely receive 1 million British pounds in one year based on a business contract it has with the British government. Like most firms, Carlotto Co. is risk averse and takes on risk only when the potential benefits outweigh the risk. It has no other international business and is considering various methods to hedge its exchange rate risk. Assume that interest rate parity exists. Carlotto Co. recognizes that exchange rates are very difficult to forecast with accuracy, but it believes that the one-year forward rate of the pound yields the best forecast of the pound’s spot rate in one year. Today the pound’s spot rate is $2.00 and the one-year forward rate of the pound is $1.90. Carlotto Co. has determined that a forward hedge is better than alternative forms of hedging. Should Carlotto Co. hedge with a forward contract or should it remain unhedged? Briefly explain.

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 14, Problem 31QA
Textbook Problem

Hedge Decision on a Project Carlotto Co. (a U.S. firm) will definitely receive 1 million British pounds in one year based on a business contract it has with the British government. Like most firms, Carlotto Co. is risk averse and takes on risk only when the potential benefits outweigh the risk. It has no other international business and is considering various methods to hedge its exchange rate risk. Assume that interest rate parity exists. Carlotto Co. recognizes that exchange rates are very difficult to forecast with accuracy, but it believes that the one-year forward rate of the pound yields the best forecast of the pound’s spot rate in one year. Today the pound’s spot rate is $2.00 and the one-year forward rate of the pound is $1.90. Carlotto Co. has determined that a forward hedge is better than alternative forms of hedging. Should Carlotto Co. hedge with a forward contract or should it remain unhedged? Briefly explain.

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