Chapter 8 SBD Answers

Chapter 8 SBD - ANSWER Yes The expected future spot rate derived from the IFE theory is the same as the forward rate Thus the results from selling

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Chapter 8: Small Business Dilemma Assessment of the IFE by the Sports Exports Company Every month, the Sports Exports Company receives a payment denominated in British pounds for the footballs it exports to the United Kingdom. Jim Logan, owner of the Sports Exports Company, decides each month whether to hedge the payment with a forward contract for the following month. Now, however, he is questioning whether this process is worth the trouble. He suggests that if the international Fisher effect (IFE) holds, the pound's value should change (on average) by an amount that reflects the differential between the interest rates of the two countries of concern. Since the forward premium reflects that same interest rate differential, the results from hedging should equal the results from not hedging on average. 1. Is Jim's interpretation of the international Fisher effect (IFE) theory correct?
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Unformatted text preview: ANSWER: Yes. The expected future spot rate derived from the IFE theory is the same as the forward rate. Thus, the results from selling pounds at the future spot rate (when not hedging) should be equal to the results from selling the pounds forward (when hedging) on average if the IFE theory holds. 2. If you were in Jim's position, would you spend time trying to decide whether to hedge the receivables each month, or do you believe that the results would be the same (on average) whether you hedged or not? ANSWER: There is some question as to whether the IFE theory holds. Therefore, it is naive to think that the results will be the same on average whether one hedges or does not hedge. However, it is possible that one could do worse by making the hedge vs. no-hedge decision each month, but most managers would attempt to make the decision rather than ignore it....
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This note was uploaded on 02/14/2011 for the course FINANCE 640 taught by Professor Sen during the Fall '10 term at UMBC.

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