SMALL BUSINESS DILEMMA
Response to the following problem:
Assessment of the IFE by the Sports Exports Company very month, the Sports Exports Company receives a payment denominated in British pounds for the footballs it exports to the United Kingdom. Jim Logan, owner of the Sports Exports Company, decides each month whether to hedge the payment with a forward contract for the following month. Now, however, he is questioning whether this process is worth the trouble. He suggests that if the international Fisher effect (IFE) holds, the pound's value should change (on average) by an amount that reflects the differential between the terest rates of the two countries of concern. Because the forward premium reflects that same interest rate differential, the results from hedging should equal the results from not hedging on average.
1. Is Logan's interpretation of the IFE theory correct?
2. If you were in Logan's position, would you spend time trying to decide whether to hedge the receivables each month, or do you believe that the results would be the same (on average) whether you hedged or not?