Shrewsbury Herbal Products, LTD.
Shrewsbury Herbal Products, located in central England close to the Welsh border, is an old-line producer of herbal teas, seasoning, and medicines. its products are marketed all over the United Kingdom and in many parts of continental Europe as well. Shrewsbury generally invoices in British pound sterling when it sells to foreign customers in order to guard against adverse exchange rate changes. Nevertheless it has just received an order from a large wholesaler in central France for 320,000 pound of its products, conditional upon delivery being made in three months' time and the order invoiced in euros. Shrewsbury's controller, Elton Peters, is concerned with whether the pound will appreciate versus the euro over the next three month, thus eliminating all or most of the profit when the euro receivable is paid. He thinks this an unlikely possibility, but he decides to contact the firm’s banker for suggestions about hedging the exchange rate exposure. Mr. Peters learns from the banker that the current spot exchange rate in euros/pound is 1.4537 pound thus the invoice amount should be 465,184 euros. Mr. Peters also learns that the three-month forward rates for the pound and the euros versus the US dollar are $1.8990/1.00 pound. and 1.3154/1.00 euros respectively. The banker offers to set up a forward hedge for selling the euro receivable for pound sterling based on the euro/pound forward cross-exchange rate implicit in the forward rates against the dollar. What would you do if you were Mr. Peters?