Dozier Industries Case Solution
- Based on the most recent information you can find, what is the expected future spot rate for April 14, 1986?
Based on the most recent information, and information given in the case the spot rate of January 14th 1956 was 1.437 dollars against one pound. Similarly, forward rate in that month was 1.4198 dollars against the pound. Meanwhile, before coming to calculations we need to understand the relationship between the spot rate and forward rate. Spot rate is a rate on which a transaction can be done, and it is the current market rate. Whereas, the forward rate is a rate that is fixed for next time period over contract.
The difference between forward rate and spot rate could be understood by an example that forward rate is discounted value of present value, and the spot is present value. So, when spot rate is discounted then it is presented as the forward rate for a specific time period. Similarly, if spot rate is discounted to get forward rate so spot rate could also be computed by reversing the formula. See Spreadsheet for the calculations. The expected future spot rate for the April, 14 1986.
- Of the two hedging techniques, the forward and the spot hedges, which is more profitable? Do they have equivalent risk?
There are two hedging techniques one is forward and second is spot transaction. The forward contract is a customizable contract between two parties to buy or sell an asset on a specified date at a fixed price. Meanwhile, these contracts are traded at centralized exchange thus they are regarded as over-the-counter (OTC) instruments. On the other hand, the spot transaction is buying or selling of currency, commodity, or other financial instrument on immediate basis. In this technique spot transaction is made in two working days, and before company already had achieved loan in pounds, and before the maturity company would use its receipts to repay the loan.
Forward contract is more profitable than second technique because the forward contract is more flexible and customizable. In forward contract downside of risk is mitigated through the contract because changes in spot rate would be hedged by the contract because company would be able to get money at the fixed rate which it has fixed at the time of transaction. On the other hand, the spot transaction is not much flexible, since it is uncertain that what would be the downside risk for the company. Meanwhile, both types of contracts have risk of default because these are not regulated contracts or transactions but these are over-the-counter contracts, and transactions.
- What should Richard Rothschild do?
Rothschild has been concerning about the payment to be received into pounds after 90 days of sales contract with a company in United Kingdom. So, the recent fluctuations in the exchange rate have increased the concern for the company. Because, the company would receive amount in pounds from its clients, but it has been spending on the current spot rate since expense made from dollars are converted into pounds. So, concern for the company increases due to the increased risk of rate of fluctuations. It is important to know that Rothschild has to mitigate or hedge the downside of risk of currency fluctuations. So, the forward contract is the best option for Rothschild to purchase a forward contract to sell pounds on a specific date in the future. In this way Rothschild would be able to hedge the downside of the risk, and avoid a huge potential loss due to the currency exchange rate ups and downs………………..
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