For each of the following two foreign exchange scenarios, one an international purchase and the other an international sale a) show the value of the transaction today in US$ b) provide an example exchange rate for a potential depreciation of the US$ and show the effect of this depreciated US$ on the value of the transaction in US$ c) provide an example exchange rate for a potential appreciation of the US$ and show the effect of this appreciated US$ on the value of the transaction in US$ d) determine the effect of a forward contract on the value of the transaction in US$ e) determine the effect of asset-liability hedging on the value of the transaction in US$ f) make a recommendation of whether the company should use a forward contract or asset-liability hedging in order to protect itself from foreign exchange risk.
Tough Appliances in the United States has just sold Israel Shekel (ILS) 2,500,000 of its appliances to Save-Money Outlets of Tel Aviv, Israel. Tough Appliances will receive the payment for this sale in 3-months and would like to guard itself against movements in the foreign exchange rate between the US$ and the ILS. The current exchange rate is US$0.2861/ILS and a 3-month forward contract is US$0.2879/ILS. The annual current deposit rate in Israel is 0.525% and the annual prime lending rate is 0.1%. Tough Appliance's cost of capital is 7.50% per annum.