Response to the following problem:
Assessment of Prevailing Spot and Forward Rates by the Sports Exports Company
As the Sports Exports Company exports footballs to the United Kingdom, it receives British pounds. The check (denominated in pounds) for last month's exports just arrived. Jim Logan (owner of the Sports Exports Company) normally deposits the check with his local bank and requests that the bank convert the check to dollars at the prevailing spot rate (assuming that he did not use a forward contract to hedge this payment). Logan's local bank provides foreign exchange services for many of its business customers who need to buy or sell widely traded currencies. Today, however, Logan decided to check the quotations of the spot rate at other banks before converting the payment into dollars.
1. Do you think Logan will be able to find a bank that provides him with a more favorable spot rate than his local bank? Explain.
2. Do you think that Logan's bank is likely to provide more reasonable quotations for the spot rate of the British pound if it is the only bank in town that provides foreign exchange services? Explain.
3. Logan is considering using a forward contract to hedge the anticipated receivables in pounds next month. His local bank quoted him a spot rate of $1.65 and a 1-month forward rate of $1.6435. Before he decides to sell pounds 1 month forward, he wants to be sure that the forward rate is reasonable, given the prevailing spot rate. A 1-month Treasury security in the United States currently offers a yield (not annualized) of 1 percent, while a 1-month Treasury security in the United Kingdom offers a yield of 1.4 percent. Do you believe that the 1-month forward rate is reasonable given the spot rate of $1.65?