Net receipts
When the exchange rate is GBP1 = EUR1.37
Option 1: Forward contract
We subtract the forward points from the spot rates since the bid forward point is greater than ask forward points.
Beck Plc. will have 8.5 million euros hence it will buy British pounds at the ask rate.
Amount receivable = 8,500,0001.4047 = GBP 6,051,114.11
Net amount received = amount receivable – forward contract cost/premium
= 6,051,114.11 – 0
= GBP 6,051,114.11
Option 2: Option hedge
We use a put option since it is a receivable.
The spot rate is more favourable than the exercise rate hence Beck Plc. will not exercise the option.
Amount receivable = 8,500,0001.37 = GBP 6,204,379.60
Option premium = 8,500,000100 = GBP 85,000
Net receipt = 6,204,379.60 - 85,000
= GBP 6,119,379.60
Option 3: Do Nothing
Net receipt = 8,500,0001.37 = GBP 6,204,379.60
When the exchange rate is GBP1 = EUR 1.43
Option 1: Forward contract
Amount receivable = 8,500,0001.4047 = GBP 6,051,114.11
Net amount received = amount receivable – forward contract cost/premium
= 6,051,114.11 – 0
= GBP 6,051,114.11
Option 2: Option hedge
The exercise rate is more favourable than the spot rate hence Beck Plc. will exercise the option.
Amount receivable = 8,500,0001.4180 = GBP 5,994,358.30
Option premium = 8,500,000100 = GBP 85,000
Net receipt = 5,994,358.30 - 85,000
= GBP 5,909,358.30
Option 3: Do Nothing
Net receipt = 8,500,0001.43 = GBP 5,994,055.94
Recommendation on the optimal method
As shown above, when the exchange rate is GBP1= EUR1.37, doing nothing yields the highest net receipt followed by the option hedge while the forward hedge option gives the least receipt. Worst still, the net receipt on forward contract hedge is exclusive of the cost of the contract. When the exchange rate is GBP1 = EUR1.43, doing nothing still gives the highest net receipt. The option hedge gives the highest gross receipt, but the option premium makes the net receipt lower than that of doing nothing. There is no change in the receipt from the forward contract hedge since the company has no option of exchanging the euros at the spot rate even if the forward rate is unfavourable (Agarwal, 2009). Therefore, doing nothing is the best alternative since it gives the highest receipt under the two expected scenarios.
The impact of ISIS and terrorist attacks on the GBP/EUR exchange rate
Introduction
ISIS and other terrorist organizations have been causing shockwaves around the world. Their attacks have been particularly targeted at the West. Recently, they have carried out terrorist attacks in Belgium, France, Turkey, among other places. Their activities have also led to the current refugee and migrant crisis facing Europe. This section analyses the impact of these on the GBP/EUR exchange rate.
Impacts
Terrorist attacks and warnings by ISIS and other violent extremist organizations increase fear and uncertainty among businesses and investors. The growing fear makes investors look for safe-haven currencies such as the Swiss Franc and the Japanese Yen as well as gold, US Treasury bills, among others. This reduces the supply of the Euro and GBP thereby reducing the exchange rate. After the attack at Charlie Hebdo, the exchange rate fell albeit for only two days (Reuters, 2016). The greatest impact is created by short-term investors who monitor daily changes and take immediate actions to protect their positions (Moles, 2011). If all the investors in the financial markets were long-term investors, isolated terrorist attacks would not affect the exchange rate.
Besides, terrorism activities affect the rate of business activities in the region thereby reducing currency flows. Most businesses suspend their operations during such periods. The most affected sector is the airline industry. Airline companies cancel their flights leading to revenue losses. For instance, following today’s (Tuesday 22 March) terrorist attack at the Brussels Airport, the government has suspended all public transport (Monfort, 2016). These attacks have already contributed to the fall in the pound’s exchange rate on Tuesday although its impact on global haven currencies has been limited. Besides, increased terrorist activities also increase insurance costs for businesses. Some insurance companies even re-evaluate their cover for terrorism. They have also led to tight border controls and immigration rules that limit the inflow of foreign currencies into the country. A fall in the supply of foreign currencies will in turn cause a depreciation of the British pound thus causing a fall in the exchange rate (Madura, 2014).
Terrorism activities also lower the confidence of the investors in the government and the economy. Frequent terrorist attacks make investors doubt the government’s resilience and ability to combat the attacks. In such cases, businesses begin to downscale their operations and some move to countries considered to be safer. The loss of investor and consumer confidence causes a decline in spending, investments and the deterioration of the overall economy. This weakens the values of the currencies thus leading to exchange rate depreciation. ISIS has posed a serious threat to the European Union’s security. The Paris attacks and the attack at Brussels Airport may be seen as attacks against the European Union and also the failure of Europe to keep the region secure. Some analysts believe that it may lead to increased calls for Brexit.
Another sector hardly hit by terrorism activities is tourism. The number of tourists to European countries is lowest when there are terror attacks or threats of terrorist attacks. This reduces the flow of foreign currency into the country since tourism is a major foreign exchange earner. For instance, if there is a reduction in the number of tourists to Britain, the demand for British pounds will fall thus causing a depreciation in the exchange rate. Europe faces the threat of terrorist attacks, and the migrant crisis has worsened it. Some of the attacks target tourists or tourist attraction sites. The depreciation of the exchange will occur if there is an attack as was the case of Turkey. On January 11th, there was a terrorist attack in a popular tourist location in Istanbul (Webcache.googleusercontent.com, 2016). On that day, the British Pound to Turkish Lira exchange rate fell to a historic low (Webcache.googleusercontent.com, 2016).
Conclusion
ISIS and other terrorist activities have adverse effects on the exchange rate. They increase fear and uncertainty among investors thus reducing the demand for currencies other than the global safe havens such as the Swiss Franc and the Japanese Yen. Attacks also cause disruption of business especially the airline industry. Other impacts include a reduction in tourism, reduction in investors’ confidence, among others. These leads to the depreciation of the exchange rate.
Bibliography
Agarwal, O. (2009). International financial management. Mumbai [India]: Himalaya Pub. House.
Madura, J. (2014). International financial management. Mason, Ohio: Thomson/South-Western.
Moles, P. (2011). Corporate finance. Hoboken, N.J.: Wiley.
Monfort, J. (2016). Why the Pound is Suffering in Wake of Brussels Terror Attack and Moody's Assessment on Brexit. [online] The Pound Sterling Live - Today's Rolling Coverage of the British Pound Sterling. Available at: https://www.poundsterlinglive.com/gbp-live-today/4102-pound-overshadowed-by-brussels-bombings-and-negative-budget-reception [Accessed 22 Mar. 2016].
Reuters. (2016). Paris attacks seen causing short-term global markets drop. [online] Available at: http://www.reuters.com/article/us-france-shooting-markets-idUSKCN0T402N20151115 [Accessed 22 Mar. 2016].
Webcache.googleusercontent.com. (2016). Turkish Lira (TRY) Exchange Rate Battered Today by Domestic Terrorism | HLF51 Currency News UK. [online] Available at: http://webcache.googleusercontent.com/search?q=cache:http://hlf51.com/forecast/20160112-14517_try-gbp-usd-currency-market-news-and-exchange-rate-outlook-.html [Accessed 22 Mar. 2016].
