INFO-240 – The check (denominated in pounds) for last month’s exports

Subject: Business    / Finance

The check (denominated in pounds) for last month’s exports just arrived. Mr. Logan normally deposits the check with his local bank and requests that the bank convert the check to dollars at the prevailing spot rate (assuming that he did not use a forward contract to hedge this payment). Logan’s local bank provides foreign exchange services for many of its business customers who need to buy or sell widely traded currencies. Today, however, Logan decided to check the quotations of the spot rate at other banks before converting the payment into dollars.

1. Mr. Logan wants to know whether your firm thinks that this is a worthwhile thing for him to do so. Specifically, will he be able to find a bank to provide him with a more favorable spot rate than his local bank? Explain?

2. Do you think that Mr. Logan’s bank is likely to provide more reasonable quotations for the spot rate of the British pound if it is the only bank in town that provides foreign exchange services? Explain?

3. Logan is also considering using a forward contract to hedge the anticipated receivables in pounds next month. His local bank quoted him a spot rate of $1.35 and a 1-month forward rate of $1.3435. Before he decides to sell pounds 1 month forward, he wants to be sure that the forward rate is reasonable, given the prevailing spot rate. A 1-month Treasury security in the U.S. currently offers a yield (not annualized) of 1%, while a 1-month Treasury security in the U.K. offers a yield of 1.4%. Does your firm believe that the 1-month forward rate is reasonable given the spot rate of $1.35?