Case A: Additional Information • You should treat January 14, 1986, as the date when you are performing your analysis and acting on the analysis (hedging or not hedging). • The prime rate is the rate at which the bank lends to its most creditworthy corporate customers. It is lending from the banks perspective, but borrowing from Dozier's perspective. • Deposits are borrowing on the part of a bank, but lending from the perspective of a customer such as Dozier. • To reduce risk, Dozier will take the 10% initial deposit (pounds) and sell the pounds in the spot market on Jan 14. • Any dollars that Dozier receives on Jan 14 are deposited in the bank for 90 days. Questions:
1. If Dozier uses the forward contract to hedge, what is Dozier's profit in US dollars?
(Hint: Since Dozier's motive is hedging, you first calculate the revenue in dollars that Dozier will receive for the Pound receivable. Then subtract Dozier's Costs given in exhibit 3.)
A forward contract is normally entered into to hedge oneself against exchange risk, or the insecurity regarding the exchange rate movements or fluctuations. By entering into a forward contract Dozier Industries will be locking the exchange rate which they will buy or sell the currency. This method ensures Dozier can make a profit in this financial transaction and it reduces the risk of loss by entering in a 90 day forward contract.
If the company does decide to go with the forward contract they will be receiving on the April 14th for their remaining receivable of £1,057,500, at the current 3-month forward rate of 1.4198 a total guarantee amount of $1,501,438.50 (1,057, 500* 1.4198). In addition, it is mentioned on the notes above that Dozier received a deposit of £117,500; which sold at the spot market on Jan 14th at the current spot rate of 1.437 for a total of $168,847.50 (117,500 * 1.4370); which is