Farah Jeans of San Antonio, Texas is completing a new assembly plant near Guatemala City. A final construction payment of Q8,400,000 is due in six months [“Q” is the symbol for Guatemalan quetzals]. Farah uses 20% per annum as its weighted average cost of capital. Today’s foreign exchange and interest rate quotations are as follows:
Present spot rate: Q7.0000/$
Six-month forward rate: Q7.1000/$
Guatemalan six-month interest rate: 14.00% per annum
US dollar six-month interest rate: 6.00% per annum
Farah’s treasury manager, concerned about the Guatemalan economy, wonders if Farah should be hedging its foreign exchange risk. The manager’s own forecast is as follows:
Highest expected rate: Q8.0000/$, reflecting a significant devaluation
Expected rate: Q7.3000/$
Lowest expected rate: Q6.4000/$, reflecting a strengthening of the quetzal
What realistic alternatives are available to Farah for making payment? Which method would you select, and why?
1 answer