Question

A Canadian based tire company is due a 2,500,000 SGD payment from its Singapore based distributor in 2 months. The Canadian firm hedges the exchange rate risk using a forward contract priced at 0.80 CAD/SGD. If the Singapore dollar depreciates over the next 2 months to a spot rate of 0.73 CAD/SGD, how much more or less will the Canadian-based tire firm receive in Canadian dollars by hedging versus an unhedged position ?

Answer 1

Payment due from Singapore = SGD 2,500,000

Forward contract rate (hedging rate) = 0.80 CAD/SGD

2 months spot rate (unhedged rate) = 0.73 CAD/SGD

1. Equivalent amount in CAD after 2 months with the hedging position:

Amount in SGD * forward rate of CAD/SGD = SGD 2,500,000* 0.80 CAD/SGD = CAD 2,000,000

2. Equivalent amount in CAD after 2 months with the un-hedging position:

Amount in SGD * 2 months spot rate of CAD/SGD = SGD 2,500,000* 0.73 CAD/SGD = CAD 1,825,000

Thus, by taking a hedging position of fixing the forward rate ay 0.80 CAD/SGD, the Canadian based firm is receiving CAD 2,000,000 which is CAD 175,000 higher than unhedged position receivable of $1,825,000.

Hence, the Canadian-based tire firm will receive 175,000 (2,000,000-1,825,000) more in Canadian dollars by hedging versus an unhedged position.