Question

FML Inc in the US sold a piece of equipment to a London company at 1 billion pounds (London currency). The payment is due in 90 days in pounds. To hedge its position, FML can:

Answer 1

FML Inc of US sold a piece of equipment to a london company at 1 billion pounds and payment is due in 90 days.

1. It can be seen that FML Inc has 1 billion pounds receivable and the company is afraid of rate of pound falling after 90 days. If the exchange rate of pound equivalent to Dollars falls then it will lead to less cash inflow to FML Inc.
2. So in order to Hedge its position it should enter into Forward Cover.
3. Forward Cover acts as a Hedge against exchange rate fluctuations.
4. The rate for Forward Cover although is for a future date but it is determined at an earlier stage.
5. FML Inc would receive the price contracted as per Forward Cover irrespective of the price that will be after 90 days.
6. Thus FML Inc should enter into a Forward Covert to hedge its position.