Question

Suppose that your firm is considering committing to a major sale of goods in Great Britain. The sale is denominated in pounds and the pound price will be set now, but your firm won't receive payment for 6 months. What are the risks to your firm? If the sale is for 1 million pounds calculate the dollar proceeds for the firm if the sale is hedged with a 6 month forward contract.

Answer 1

Suppose, the current spot rate is 0.75 pound/ Dollar ,

or 1.33 dollar/pound

We are to receive 1 million pounds, suppose we lock in a rate of 1.45dollar/pound after six months, by entering into forward contract.

The risks of not entering a forward contract and remain unhedged are:

• The value of pound falls, if the value of pound rises, we will receive fewer dollars upon conversion.
• If the value of dollar rises, we will receive fewer pounds upon conversion.
• Due to currency fluctuations we might receive a lower value of the original sales made.

upon conversion we will receive $1,45,000 at the rate locked it.

Now, if the spot rate after 6 months would be 1.48dollar/pound the investor would have lost a few dollars. If the spot rate was 1.30 Dollar/pound, we have gained by entering into the contract.