Question

XYZ Co. will require 2 million Polish zloty in 3 years to purchase imports. Assume interest rate parity holds. Assume that the spot rate of the Polish zloty is $.30. The 3-year annualized interest rate in the United States is 5 percent, and the 3-year annualized interest rate in Poland is 11 percent. If XYZ Co. uses a forward contract to hedge its payables, how many dollars will it need in 2 years?

Answer 1

Sol:

Polish zloty required to purchase imports = 2 million

Polish zloty spot rate = $0.30

Annualized interest rate in US = 5%

Annualized interest rate in Poland = 11%

Number of years (n) = 2

Expected forward rate for Polish Zloty (EFR) = Polish zloty spot rate x (1 + Annualized interest rate in US)^n / (1 + Annualized interest rate in Poland )^n

EFR = 0.30 x (1+5%)^2/(1+11%)^2

EFR = 0.30 x (1.05)^2/(1.11)^2

EFR = 0.33075/1.2321

EFR (per polish zloty) = 0.2684

Required import payment in dollars = Import payment in Polish Zloty x Forward rate of Polish Zloty

Required Import payment in dollars = 2,000,000 x 0.2684

Required Import payment in dollars = $536,800

Therefore dollars will it need in 2 years = $536,800