Question

On 1/7/20x8, you enter into a contract to buy 10 million of ABC Bhd’s shares on 31/12/20x8 from your Malaysian friend at RM10 per share on 31/12/20x8. On 1/7/20x8, the spot exchange rate is RM1.00 = S$0.30, and the 6-month forward exchange rate is RM1.00 = S$0.31 (to buy RM), and RM1.00 = S$ 0.28 (to sell RM). Assume you want to ensure that you will not be exposed to foreign currency risk when you acquire the shares on 31/12/20x8.

Question (i): should you now enter into a forward exchange contract to buy/sell RM100 million on 31/12/20x8?

Question (ii): if the spot exchange rate is RM1.00=0.40 on 31/12/20x8, how much (net in S$) will you have to pay to buy the shares?

Question (iii): if the spot exchange rate is RM1.00=0.25 on 31/12/20x8, how much (net in S$) will you have to pay to buy the shares?

Answer 1

Purchase of 10Million shares of ABC will require = 10million* 10 = 100Million RM

Spot Rate= 0.3$ .

Forward Rate = .31$. We will use Buy rate because we will have to make payment and hence buy RM against $.

If we pay spot then will purchase RM against $ using spot rate and therefore Outflow= 100million*.3= $30Million

If we pay Forward then will purchase RM against $ using Forward rate and therefore Outflow= 100million*.31= $31Million

1. Hence from above, it is clear that entering into forward contractwill require higher outflow, Hence we should not enter into forward exchange contract. Savings will be $1 Million

2. If spot exchange rate= .4$ then outflow = 100Million*.4 = $40Million.

3. If spot exchange rate= .25$ then outflow = 100Million*.25 = $25Million.

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