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A U.S. Corporation, Eternal Beauty, Inc., imports 125,000 British Pounds (£) worth of cosmetics from England. It has a choice of getting 2% discount from the supplier if it were to pay now (in £); otherwise the whole invoice amount (in £) is due in three months. The foreign exchange spot rate is US\$1.20/£. 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/£, how much US\$ is needed to make the payment in 3 months?

c. Eternal Beauty could also use an option to hedge £125,000 in payables. The premium paid is US\$0.02/£ and the exercise price is US\$1.21/£. If the option is exercised, what is the total dollar amount paid (including the premium)?
in Economics and Finance by Bronze Status (5,562 points) | 117 views

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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\$ $1.22 / £$, how much US\$ is needed to make the payment in 3 months?
Total US\$ needed in 3 months $=£ 125,0000$ * USS1.22/\& = $\underline{\text { 152,500 }}$

Eternal Beauty could also use an option to hedge $£ 125,000$ in payables. The premium paid is US\$ $0.02 / \mathrm{f}$ and the exercise price is US\$1.21/£. If the option is exercised, what is the total dollar amount paid (including the premium)?
by Bronze Status (5,562 points)

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