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A U.S. Corporation, Eternal Beauty, Inc., imports 125,000 British Pounds (&pound;) worth of cosmetics from England. It has a choice of getting 2% discount from the supplier if it were to pay now (in &pound;); otherwise the whole invoice amount (in &pound;) is due in three months. The foreign exchange spot rate is US\$1.20/&pound;. Eternal Beauty has the following choices: a. Borrow from a U.S. bank for 3 months to take advantage of the 2% discount. The bank will charge a 15% annual interest rate. How much will Eternal Beauty have to pay the bank in 3 months? b. If Eternal Beauty were to hedge its position with a 3-month forward contract at a forward exchange rate of US\$1.22/&pound;, how much US\$is needed to make the payment in 3 months? c. Eternal Beauty could also use an option to hedge &pound;125,000 in payables. The premium paid is US\$0.02/&pound; and the exercise price is US\$1.21/&pound;. If the option is exercised, what is the total dollar amount paid (including the premium)? | 117 views ## 1 Answer 0 like 0 dislike Best answer Borrow from a U.S. bank for 3 months to take advantage of the$2 \%$discount. Based on Eternal Beauty's credit history, the bank will charge a$15 \%$annual interest rate. How much will Eternal Beauty have to pay the bank in 3 months? Get 2\% discount, pay only$0.98 *  \textsterling 125,0000=  \textsterling 122,500$At the spot exchange rate of US\$1.20/f, need to borrow $\ \mathbf{1 4 7}, \mathbf{0 0 0}$.

$\pounds 122,500^{*}$ US $1.20 / \textsterling =\$ 147,000$In 3 months, need to pay principal plus interest to the bank. Total amount paid $=\ \mathbf{1 4 7}, \mathbf{0 0 0}^{*} (1.15) { }^{(1 / 4)} \underline{\text { 152,227.04 }}$ If Eternal Beauty were to hedge its position with a 3 -month forward contract at a forward exchange rate of US\$ $1.22 / &pound;$, how much US\$is needed to make the payment in 3 months? Total US\$ needed in 3 months $=&pound; 125,0000$ * USS1.22/\& = $\underline{\text { 152,500 }}$

Eternal Beauty could also use an option to hedge $&pound; 125,000$ in payables. The premium paid is US\0.02 / \mathrm{f}$and the exercise price is US\$1.21/&pound;. If the option is exercised, what is the total dollar amount paid (including the premium)?
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