Cost of the Basic Hedging Techniques
Application Selective Hedging
In March, Multinational Industries, Inc. (MII) assessed the September spot rate for sterling at the following rates:
$1.80/£ with probability 0.15
$1.85/£ with probability 0.20
$1.90/£ with probability 0.25
$1.95/£ with probability 0.20
$2.00/£ with probability 0.20
a. What is the expected spot rate for September?
Solution. The expected future spot rate is 1.80(0.15) + 1.85(0.2) + 1.90(0.25) + 1.95(0.20) + 2.00(0.20) = $1.905.
b. If the six-month forward rate is $1.90, should the firm sell forward its £500,000 pound receivables due in September?
Solution. If MII sells its pound proceeds forward, it will lock in a value of $950,000 (1.90 × 500,000). Alternatively, if it decides to wait until September and sell its pound proceeds in the spot market, it expects to receive $952,500 (1.905 × 500,000). Based on these figures, if MII wants to maximize expected profits, it should retain its pound receivables and sell the proceeds in the spot market upon receipt.