Question

The Finnish Company you are working in, expect to receive from its Swedish suppliers 1.3 million SEK (Swedish krona) in exactly one year from now. Current exchange rate is 9.60 Eur/SEK (e.g. 9.65 SEK per one EUR). a. Describe specifically what exchange rate risk the Finnish company faces and how this risk can be hedged by using forward contracts. b. Calculate the one year Forward rate for EUR/SEK based on covered interest rate parity. c. Calculate the hedged value of receivable in Finnish company.

Answer 1

a) exchange rate risk is a risk faced when any transaction is made in currency other than the domestic country. over here Finnish Company is expected to receive money from Swedish company. Over a course of a year the exchange rate can appreciate or depreiciate. Suppose it appreciates then the finnish company will be at a loss. To avoid this people go for forward contract. By using this the finnish company can enter into agreement with the swedish company to use the present exchange rate only in the future. By this the finnish company can hedge the risk.

b) So the forward rate will be same as the currect exchange rate. 9.60 eur/ sek

Becuase in this we freeze the same rate for the forward contract that will be used after one year.

c) 9.65 SEK= 1 EUR

1 SEK= 1/9,65 EUR

1.3 MILLION SEK= 1.3 BILLION / 9.65 EUR

=0.1347 Billion EUR (ans)

This will be the amount receivable by the Finnish company.