Du Pont has entered into a currency risk sharing arrangement with British Gas. Under the contract, Du Pont agrees to pay British Gas a base price of $10 million for gas purchases, but the parties would share the currency risk equally beyond a neutral zone.The neutral zone is between $/£1.67 and $/£1.73. Within the neutral zone, Du Pont must pay BG the pound equivalent of $10 million at the base rate of $1.70.
(a) Within the neutral zone, how much does Du Pont owe British Gas in pounds? What is the dollar cost of the gas purchases for DuPont?
(b) Suppose the spot rate at the time of payment is £1 = $1.63. How much does Du Pont owe British Gas in pounds? What is the dollar cost of the gas purchases for DuPont?
(c) Suppose the spot rate at the time of payment is £1 = $1.77. How much does Du Pont owe British Gas in pounds? What is the dollar cost of the gas purchases for DuPont?
(d) Why does British Gas like this contract?