Laguna ltd, a recreational business based in the Seychelles, has placed an order to import 10 inflatable boats with outboard motors from the UK, at a cost of GBP 1,800 each

Subject:FinancePrice:3.87 Bought7

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Laguna ltd, a recreational business based in the Seychelles, has placed an order to import 10 inflatable boats with outboard motors from the UK, at a cost of GBP 1,800 each. The goods are to be shipped from the UK immediately, but payment in GBP is only required to be made in 3 months' time. Laguna ltd uses a bank overdraft account that is fully drawn, and the company has no spare cash to finance the credit period.

The exchange rates between pound sterling (GBP) and Seychellois Rupee (SCR) are as follows.

GBP / SCR

Spot                              GBP 1 = SCR 16.6191 - 18.9751

1 month forward            GBP 1 = SCR 16.7183 - 19.0487                                                                    

3 months forward          GBP 1 = SCR 16.9146 - 19.1655

The company can borrow and deposit short-term funds in the London and Seychelles markets at the following rates.

                        London(GBP)                           Seychelles(SCR)

Borrowing rate 4.8% p.a.                                 12% p.a.

Deposit rate 2.4% p.a                                       8% p.a.

Laguna ltd does not have an established risk management policy. The company's finance director is undecided about whether the currency risk of the transaction should be covered through the forward market or the money market.

Required: Advise Laguna ltd whether the forward market or the money market would offer the cheaper hedge. Your recommendations should be supported by appropriate calculations. Ignore transaction costs.