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    Mini Case: Shrewsbury Herbal Products, LTD

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    SriSaraswathy
    Shrewsbury Herbal Products has received a large order from France that is to be invoiced in euros in 3 months. Their controller is concerned about exchange rate fluctuations between the euro and pound sterling over this period eliminating their profits. After speaking to their banker, the controller learns that euros are expected to appreciate relative to pounds in the forward market. Therefore, the controller should sell the future euros from this invoice in the forward market at the euro/pound forward rate to lock in the current pound value and ensure profits are maintained.

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    Mini Case: Shrewsbury Herbal Products, LTD

    Uploaded by

    SriSaraswathy
    1K views7 pages
    Shrewsbury Herbal Products has received a large order from France that is to be invoiced in euros in 3 months. Their controller is concerned about exchange rate fluctuations between the euro and pound sterling over this period eliminating their profits. After speaking to their banker, the controller learns that euros are expected to appreciate relative to pounds in the forward market. Therefore, the controller should sell the future euros from this invoice in the forward market at the euro/pound forward rate to lock in the current pound value and ensure profits are maintained.

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    Shrewsbury Herbal Products has received a large order from France that is to be invoiced in euros in 3 months. Their controller is concerned about exchange rate fluctuations between the euro and pound sterling over this period eliminating their profits. After speaking to their banker, the controller learns that euros are expected to appreciate relative to pounds in the forward market. Therefore, the controller should sell the future euros from this invoice in the forward market at the euro/pound forward rate to lock in the current pound value and ensure profits are maintained.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    1K views7 pages

    Mini Case: Shrewsbury Herbal Products, LTD

    Uploaded by

    SriSaraswathy
    Shrewsbury Herbal Products has received a large order from France that is to be invoiced in euros in 3 months. Their controller is concerned about exchange rate fluctuations between the euro and pound sterling over this period eliminating their profits. After speaking to their banker, the controller learns that euros are expected to appreciate relative to pounds in the forward market. Therefore, the controller should sell the future euros from this invoice in the forward market at the euro/pound forward rate to lock in the current pound value and ensure profits are maintained.

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    You are on page 1of 7

    MINI CASE: SHREWSBURY

    HERBAL PRODUCTS, LTD


    • Shrewsbury Herbal Products, located in central England close
    to the Welsh border, is an old-line 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.
    • Shrewsbury’s 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 firm’s banker for
    suggestions about hedging the exchange rate exposure.
    • Mr. Peters learns from the banker that the current spot
    exchange rate 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/£ and $1.3154/€, 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?


    Shrewsbury: Simple Answer
    • F3(€/£) = F3($/£) ÷ F3($/€) = 1.8990 ÷ 1.3154 =
    €1.4437/£
    • Current S(€/£) = €1.4537/£.
    • € is expected to appreciate in value relative to £ in
    three months.
    • In other words, € is trading at a premium to £ in
    the forward market.

    • Thus, sell € at the forward for £ @ €1.4437/£. 


    “Lock in” £322,217 (= €465,184/1.4437).
    • Even better-off for Shrewsbury!!
    – Export = £320,000
    Extension I
    • What would happen if € is trading at a
    forward discount against £?
    Extension I
    • What would happen if € is trading at a
    forward discount against £?

    • Whether it would lead to a loss for the


    company would depend upon the extent of
    the discount and the markup, i.e., the amount
    of profit built into the price of £320,000.
    • If the discount > the markup  loss!
    Extension II
    • Is it possible for Shrewsbury to receive exactly
    £320,000 at the end of three-month accounts
    receivable period when invoiced in € (i.e.,
    perfectly hedging the € exposure)?
    Extension II
    • Is it possible for Shrewsbury to receive exactly
    £320,000 at the end of three-month accounts
    receivable period when invoiced in € (i.e., perfectly
    hedging the € exposure)?

    • Yes when Shrewsbury could establish the € invoice


    amount by use of the forward exchange rate instead
    of the current spot rate.
    • The invoice amount then 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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