Harmony of Manhattan, New York, is building a new factory in Malaysia. In three months, the company has to pay RM 30,000,000. The currency is Malaysian Ringgit. Harmony's weighted average cost of capital is 15%. The foreign exchange and interest quotations are the following:
Construction payment due in three months (A/P, Ringgit) 30,000,000
Present spot rate (RM/$) 4.0000
Three-month forward rate (RM/S) 4.2000
Malaysian three-month interest rate (per annum) 8.000%
U.S. dollar three-month interest rate (per annum) 4.000%
Harmony's weighted average cost of capital (WACC) 15.000%
Harmony's treasury manager, concerned about the exchange rate fluctuations, contemplates hedging its foreign exchange risk. The manager's own forecast is as follows:
Expected spot rate in three-months (RM/S):
Highest expected rate (reflecting a significant devaluation) 4.8000
Expected rate 4.5000
Lowest expected rate (reflecting a strengthening of the RM) 3.8000
1. What realistic alternatives are available to Harmony for making payments?
2. Which method would you select ar why?