Question

Your firm is located in the U.S and a major customer is located in Europe. DUe to historical negotiations, your customers pay your firm in euros. Your firm has just recorded a sale to the customer for 50,000,000 pounds. The cusotmer has 30 days to pay the invoice. The current spot rate is 1 pound = $1.38. The foreign exchange expert at your firm believes the foreign exchange rate in 30 days will either be 1 pound = $1.10 or 1 pound = $1.50. Assuming that the U.S dollar depreciates, what is the expected U.S dollar value of the sale at the future exchange rate?

Answer 1

Current exchange rate is 1 pound = $ 1.38

This means we need to give 1.38 dollars to buy 1 pound

If US dollar depreciates, it means we need to give more than 1.38 dollars to buy 1 pound as the value of dollar has declined so we cannot buy 1 pound in 1.38 dollars.

So future exchange rate will be 1 pound = $ 1.50

Expected US dollar value of sale will be = 50,000,000 pounds * $ 1.5 = $ 75,000,000

Value of sale at original rate = 50,000,000 pounds * $ 1.38 = $ 69,000,000

So the firm stands to gain if UD dollar depreciates in future and stands to recieve $ 6,000,000  more than original amount of sale ( 75,000,000 - 69,000,000).