Mini Case Study:

Shrewsbury Herbal
Products, Ltd.
(International Business and Trade)

Submitted to: Mrs. Dee Laila Buhian

Members:
Alaban, Courtney Elfa
Guilaran, Cris Margarette
Tumbocon, Dianne Joy

March 7, 2019
CASE:

Shrewsbury Herbal Products, located in central England close to the Welsh border, is an
old-line producer of herbal teas, seasonings, and medicines. Their 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 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 in €/£ 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
franc receivable for pound sterling based on the €/£ cross-forward exchange rate implicit
in the forward rates against the dollar. What would you do if you were Mr. Peters?

OBJECTIVE

To choose the most favorable method in earning profit and securing the value of the
invoice price.
PROBLEM:

Should Mr. Peter accept the set - up forward hedge for selling the franc receivable
for pound sterling based on the €/£ cross-forward exchange rate implicit in the forward
rates against the dollar?

GIVEN:

• Invoice price: £320,000

• Current Spot Exchange Rate: (€/£) = €1.4537

• 3 - month Forward Rates for £ and € over $ respectively: $1.8990/£1.00 and $1.3154/
€1.00

SOLUTION:

A. Using Spot Exchange Rate

Knowing that spot exchange rates is exposed to foreign exchange risks of sudden
fluctuations, we can conclude that this method is not that applicable for the situation.

For instance, if the current spot exchange rate in €/£ is €1.4537 and it will be used
by Mr. Peters, they would end up with an invoice price of €465,184 = (£320,000 x
€1.4537).

If the said current spot exchange rate will fluctuate and decrease after three months,
the required invoice price could not be met.

B. Using Forward Exchange Rate

The forward exchange rate is computed as:

F3 (€/£) = F3 ($/£) ÷ F3($/€)

= 1.8990 ÷ 1.3154

= 1.4437
 €465,184 ÷ 1.4437

= £322, 217 (the lock-in price)

On the other hand, with the use of forward exchange rate, there's a possibility to
receive the lock-in price of £322,217. This clearly indicates that the euro is trading at a
premium (which means, it was trading in a price greater than £320,000) to the British
pound.

Therefore, we can say that Shrewsbury would have a greater amount of £2,217
(£322,217-£320,000).

Shrewsbury would end up locking-in an amount less than the amount of £320,000 if
the euro was trading at a forward discount. 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
three-month accounts receivable period if it could invoice in pound sterling. That, however,
is not acceptable to the French wholesaler, given the condition that he will be paying
£320,000 of its products upon delivery being made in three months’ time. When invoicing
in euros, Shrewsbury could establish the euro invoice amount by use of the forward
exchange rate instead of the current spot rate.

After three months, Shrewsbury will receive the invoice amount of €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.

Thus, £320,000 = €461,984/1.4437.

CONCLUSION:

Therefore, Mr. Peters should accept the offer of the banker to set up a forward
hedge for selling the euro receivable for pound sterling based on €/£ forward cross-
exchange rate since, by doing so, the company could receive £322,217 which could lock-in
the said invoice price of £320,000 and could earn a £2,217 profit.