1. You are a sales manager for Motorola and export cellular phones from the United States to other countries. You have just signed a deal to ship phones to a British distributor, and you will receive £700,000 when the phones arrive in London in 180 days. Assume that you can borrow and lend at 7% p.a. in U.S. dollars and at 10% p.a. in British pounds. Both interest rate quotes are for a 360-day year. The spot rate is $1.4945 >£, and the 180-day forward rate is $1.4802 >£.
a. Describe the nature and extent of your transaction foreign exchange risk.
b. Describe two ways of eliminating the transaction foreign exchange risk.
c. Which of the alternatives in part b is superior?
d. Assume that the dollar interest rate and the exchange rates are correct. Determine what sterling interest rate would make your firm indifferent between the two alternative hedges.
2. Suppose that there is a 0.5% probability that the government of Argentina will nationalize its banking system and freeze all foreign deposits indefinitely during the next year. If the dollar deposit interest rate in the United States is 5%, what dollar interest would Argentine banks have to offer in order to attract deposits from foreign investors?