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    Shrewsbury Herbal Products, LTD

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    Wulandari Pramithasari
    Shrewsbury Herbal Products received a large order from a French wholesaler but is concerned about exchange rate fluctuations between the pound and euro over the next three months. The company's controller learns that he can hedge the exchange rate risk by selling the euros receivable at the three-month forward rate for pounds. This would allow the company to lock in a receipt of at least £320,000 for the order, protecting their profits from adverse currency movements.

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    Shrewsbury Herbal Products, LTD

    Uploaded by

    Wulandari Pramithasari
    4K views1 page
    Shrewsbury Herbal Products received a large order from a French wholesaler but is concerned about exchange rate fluctuations between the pound and euro over the next three months. The company's controller learns that he can hedge the exchange rate risk by selling the euros receivable at the three-month forward rate for pounds. This would allow the company to lock in a receipt of at least £320,000 for the order, protecting their profits from adverse currency movements.

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    Shrewsbury Herbal Products, Ltd

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    Shrewsbury Herbal Products received a large order from a French wholesaler but is concerned about exchange rate fluctuations between the pound and euro over the next three months. The company's controller learns that he can hedge the exchange rate risk by selling the euros receivable at the three-month forward rate for pounds. This would allow the company to lock in a receipt of at least £320,000 for the order, protecting their profits from adverse currency movements.

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    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    4K views1 page

    Shrewsbury Herbal Products, LTD

    Uploaded by

    Wulandari Pramithasari
    Shrewsbury Herbal Products received a large order from a French wholesaler but is concerned about exchange rate fluctuations between the pound and euro over the next three months. The company's controller learns that he can hedge the exchange rate risk by selling the euros receivable at the three-month forward rate for pounds. This would allow the company to lock in a receipt of at least £320,000 for the order, protecting their profits from adverse currency movements.

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    Shrewsbury Herbal Products, Ltd. MINI CASE: SHREWSBURY HERBAL PRODUCTS, LTD.

    Shrewsbury Herbal Products, located in central England close to the Welsh border, is an oldline producer of herbal teas, seasonings, and medicines. Its products are marketed all over the United Kingdom and in many parts of continental Europe as well. Shrewsbury Herbal generally invoices in British pound sterling when it sells to foreign customers in order to guard against adverse exchange rate changes. Nevertheless, it has just received an order from a large wholesaler in central France for 320,000 of its products, conditional upon delivery being made in three months time and the order invoiced in euros. Shrewsburys controller, Elton Peters, is concerned with whether the pound will appreciate versus the euro over the next three months, thus eliminating all or most of the profit when the euro receivable is paid. He thinks this is an unlikely possibility, but he decides to contact the firms banker for suggestions about hedging the exchange rate exposure. Mr. Peters learns from the banker that the current spot exchange rate is / is 1.4537, thus the invoice amount should be 465,184. Mr. Peters also learns that the three-month forward rates for the pound and the euro versus the U.S. dollar are $1.8990/1.00 and $1.3154/1.00, respectively. The banker offers to set up a forward hedge for selling the euro receivable for pound sterling based on the / forward cross-exchange rate implicit in the forward rates against the dollar. What would you do if you were Mr. Peters?

    Answers: Suppose Shrewsbury sells at a twenty percent markup. Thus the cost to the firm of the 320,000 order is 256,000. Thus, the pound could appreciate to 465,184/256,000 = 1.8171/1.00 before all profit was eliminated. This seems rather unlikely. Nevertheless, a ten percent appreciation of the pound (1.4537 x 1.10) to 1.5991/1.00 would only yield a profit of 34,904 (= 465,184/1.5991 - 256,000). Shrewsbury can hedge the exposure by selling the euros forward for British pounds at F3(/) = F3($/) F3($/) = 1.8990 1.3154 = 1.4437. At this forward exchange rate, Shrewsbury can lock-in a price of 322,217 (= 465,184/1.4437) for the sale. The forward exchange rate indicates that the euro is trading at a premium to the British pound in the forward market. Thus, the forward hedge allows Shrewsbury to lock-in a greater amount (2,217) than if the euro receivable was converted into pounds at the current spot If the euro was trading at a forward discount, Shrewsbury would end up locking-in an amount less than 320,000. Whether that would lead to a loss for the company would depend upon the extent of the discount and the amount of profit built into the price of 320,000. Only if the forward exchange rate is even with the spot rate will Shrewsbury receive exactly 320,000. Obviously, Shrewsbury could ensure that it receives exactly 320,000 at the end of threemonth accounts receivable period if it could invoice in . That, however, is not acceptable to the French wholesaler. When invoicing in euros, Shrewsbury could establish the euro invoice amount by use of the forward exchange rate instead of the current spot rate. The invoice amount in that case would be 461,984 = 320,000 x 1.4437. Shrewsbury can now lock-in a receipt of 320,000 if it simultaneously hedges its euro exposure by selling 461,984 at the forward rate of 1.4437. That is, 320,000 = 461,984/1.4437.

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