Ashton plc, a UK-based firm, imports computer components from the Far East. The trading currency is Singa- pore dollars and the value of the deal is 28 m Singapore dollars (S$). Three months’ credit is given. The current spot exchange rate is S$2.80 vs. £1. Because of recent volatility in the foreign exchange markets, Ashton’s direc- tors are worried that a rise in the S$ could wipe out the profits on the deal. Three alternative hedging methods have been suggested:

â–  a forward market hedge

^{â–  a money market hedge}

^{â–  an option hedge.}

Ashton’s treasurer discovers the following information:

■ The three-month forward rate is S$2.79 vs. £1

^{â–  Ashton can bor r ow in S$ at 2% inte r est (annual rate), and in London at 5% p.a.}

^{â–  Deposit rates a r e 1% p.a. in Singapo r e and 3% p.a. in London}

^{■ A th r ee-month American call option to buy S$28 m at an exe r cise rate of S$2.785 vs. £1 could be pu r chased at}

^{a p r emium of £200,000 on the London OTC option market}

Required

Show how each hedge would operate for each of the following spot rates in three months’ time:

(a) S$2.78 vs. £1

^{(b) S$2.82 vs. £1}