Question

You are bidding on a contract and if you are successful bidder the customer will owe you £100,000 payable on February 5th which of the following would be the best instrument to use in hedging this payment.

A. Forward contract

B Money Market Hedge

C Futurs contract

D Options contract

Answer 1

Answer: Forward contract

I am going to receive 100,000 Pounds on February 5^th. My risk associated with this is that Dollar will appreciate against Sterling Pounds and I may receive less dollars on February 5^th . I can hedge this risk by taking a forward cover. For example, if I take a forward cover at $ 1.4, I will receive $ 140,000 irrespective of exchange rate on February 5^th.

Forward Contract is a contract to either buy or sell an agreed amount of foreign currency , on a future date at agreed exchange rate. Both of the parties under the contract are obligated to perform.