Question

3-Exxon Oil Corp. is negotiating the purchase of 1 million barrels of oil from a bankrupt competitor to be delivered and paid for in exactly 1 year. The oil exporter wants the contract expressed in Mexican Pesos, and the current "in USD" Peso exchange rate is $0.077. The contract is signed at a price of 1435 Pesos per barrel. Exxon can enter a futures contract that allows the company to purchase Pesos at the exact time of oil delivery at $0.078. If we consider the use of the futures contract to hedge Exxon's foreign exchange risk, how much is the cost of this insurance to Exxon? $ Note: Round your answer to the closest $USD.

Answer 1

Ans:

Calculation of cost of insurance/hedging to Exxon:

Oil purchased : 1M Barrels

Price Per Barrel : 1,435 pesos per barrel

Payment to be done on Delivery : 1M*1,435 = 1,435M Maxican Pesos

Spot rate: $0.077 per maxican Pesos.

For Buying 1,435M maxican Pesos at spot rate, Dollars required :

= 1,435*0.077 = $110.495M or $110,495,000

Future rate : $0.078 per maxican Pesos.

For Buying 1,435M maxican Pesos at future rate, Dollars required :

= 1,435*0.078 = $111.93M or $111,930,000

Cost of insurance : Future Contract price - Spot price : $111,930,000 - $110,495,000 = $1,435,000

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