Question

1. A U.S. company has an account receivable of €10,000,000 from a German company to be paid in three months. The three-month forward rate for the euro is $0.50 per euro.

a. How much is the approximate value of the account receivable in U.S. dollars, if the company makes a forward hedge.

b. If in three months the spot rate for the euro has changed to $0.65 per euro, in retrospect was it advantageous for the U.S. company to go into the forward hedge? Why or why not? Support your answer.

Answer 1

a.

US company has €10,000,000 receivable in 3 months.

3 months forward rate = $0.50 per euro

If US company enters into a forward hedge, amount receivable in 3 months = 10,000,000 * 0.50 = $5,000,000

b.

In 3 months spot rate for euro = $0.65 per euro.

If no forward hedge was entered, amount received in 3 months would have been = 10,000,000 * 0.65 = $6,500,000.

Thus it would have been advantageous if no hedge would have been entered. This is becuase there would have been a gain of $1,500,000 (6,500,000 - 5,000,000) if no forward hedge would have been entered.

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