On 10 th February 2020 a UK company Bellingham Inc.

On 10^th February 2020 a UK company Bellingham Inc. exported a consignment of aircraft parts to a US airline company. Bellingham was set to receive payment in two instalments of US dollars. The payments were set to occur on the following dates:

1. $1.5 million on 10^th March 2020
2. $2.7 million on 10^th April 2020
3. $3.8 million on 10^th June 2020

Bellingham Inc. also has US dollar-denominated trade debts and plans to use proceeds from the polypropylene fabric sale to pay these suppliers. The company’s Treasury has budgeted for estimates that 30% of the March payment to be held on account to pay creditors, 20% of the April payment and 50% of the June payment.

Three years ago (10^th February 2017) Bellingham borrowed $80 million via a six-year floating-rate, non-callable, note issue. The notes were sold at par ($100) and offer a coupon rate of $LIBOR plus 300 basis points. Interest is payable semi-annually on 10^th February and 10^th August. The coupon rate is based on the six-month $LIBOR at the start of each payment cycle.

Task 1: Bellingham Inc’s Exchange Rate Risk

1. Explain Bellingham’s exchange rate exposure and generate over-the-counter forward rates for each payment based on covered interest rate parity.

1. The day-count convention applying to sterling money market transactions is actual/365 days, whilst for US dollar money market transactions it is actual/360 days.
2. In the absence of interest rates corresponding to the terms of the transactions, use the available data to interpolate a suitable rate.

2. Explain how Bellingham could use currency futures to hedge the effects of exchange rate uncertainty associated with each payments.

3. Assume that on 10^th March 2020 the GBP/USD spot rate is $1.3900-1.3905. Assess the efficiency of the futures contract hedge for the 10^th March payment if the futures price on the day is $1.3917.

4. On 10^th February a bank offers a two-month GBP/USD forward exchange rate of $1.3300. Show how an arbitrageur could profit and critically comment on the forward rate in relation to the principle of covered interest rate parity.

(You might find the point easier to discuss by assuming the arbitrageur puts into play a specific sum of money).

5. Discuss the relative merits for Bellingham of the over-the-counter and exchange-traded methods of hedging currency risk.

(Link the analysis to the specifics of your numerical outcomes of Bellingham’s risk management options. Analysis limited to textbook-style generalisations will not be well rewarded).