1. If Jim invests the excess cash in U.S. Treasury bills, would this reduce the firms exposure to exchange rate risk?
2. Jim decided to use the excess cash to pay off the British loan. However, a friend advised him to invest the cash in British Treasury bills, stating that the loan provides an offset to the pound receivables, so you would be better off investing in British Treasury bills than paying off the loan. Is Jims friend correct? What should Jim do?
|Ever since Jim Logan began his Sports Exports Company, he has been concerned about his exposure to exchange rate risk. The firm produces footballs and exports them to a distributor in the United Kingdom, with the exports being denominated in British pounds. Jim has just entered into a joint venture in the United Kingdom in which a British firm produces sporting goods for Jims firm and sells the goods to the British distributor. The distributor pays pounds to Jims firm for these products. Jim recently borrowed pounds to finance this venture, which created some cash outflows (interest payments) that partially offset his cash infl;ows in pounds. The interest paid on this loan is equal to the British Treasury bill rate plus 3 percentage points. His original business of exporting has been very successful recently, which has caused him to have revenue (in pounds) that will be retained as excess cash. Jim must decide whether to pay off part of the existing British loan, invest the cash in the U.S. Treasury bills, or invest the cash in British Treasury bills.|