Assignment Number 5 MELBOURNE MANUFACTURING
Shiela Forbes is the Chief Financial Officer [CFO] of MELBOURNE MANUFACTURING, a U.S. based manufacturer of gas turbine equipment. She has just concluded negotiations for the sale of a turbine generator to Crown, a British firm forFOUR million pounds. This single sale is quite large in relation to MELBOURNE MANUFACTURING’s present business. MELBOURNE MANUFACTURING has no other current foreign customers, so the currency risk of this sale is of particular concern. The sale is made in SEPTEMBER with payment due six months later in . Shiela Forbes has collected the following financial market information for the analysis of her currency exposure problem:
Spot Exchange rate: $1.4640 per British pound.
Six-month forward rate: $1.4549 per pound
MELBOURNE MANUFACTURING’s cost of capital: 14%
U.K. annual borrowing interest rate: 16.0% (or 8% interest for months)
U.K. annual investment interest rate: 14.0% (7% interest for months)
U.S. annual borrowing interest rate: 8.0% (4.0% interest for months)
U.S. one-year investment interest rate: 6.0% (3% interest for months)
put option in the over-the-counter (bank) market for 1,000,000 British pounds;
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