Question: Lucky 13. Lucky 13 Jeans of San Antonio, Texas, is completing a new assembly plant near Guatemala City. A final construction payment of Q8,400,000 is due in six months. ("Q" is the symbol for Guatemalan quetzals.) Lucky 13 uses 20% per annum as its weighted average cost of capital. Today's foreign exchange and interest rate quotations are as follows:
Construction payment due in 6-months (A/P, quetzals) 8,400,000
Present spot rate (quetzals/$) 7,0000
6-month forward rate (quetzals/$) 7,1000
Guatemalan 6-month interest rate (per annum) 14,000%
U.S. dollar 6-month interest rate (per annum) 6,000%
Lucky 13's weighted average cost of capital (WACC) 20,000%
Lucky 13's treasury manager, concerned about the Guatemalan economy, wonders if Lucky 13 should be hedging its foreign exchange risk. The manager's own forecast is as follows:
Expected spot rate in 6 month (quetzals/$):
Highest expected rate (reflecting a significant devaluation) 8,0000
Expected rate 7,3000
Lowest expected rate (reflecting a strengthening of the quetzal) 6,4000
What realistic alternatives are available to Lucky 13 for making payments? Which method would you select and why?