Question

Suppose a U.S. firm buys $200,000 worth of stereo speaker wire from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U.S. deficit has caused the dollar to depreciate against the peso recently. The current exchange rate is 5.50 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.25 Mexican pesos per U.S. dollar. How much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box .

Answer 1

The Value of goods in Pesos = $200000 * 5.50 pesos/$ = 1,100,000 Pesos

The US firm bought Mexican pesos at the 90-day forward rate of 5.45 pesos/$ for 1,100,000 Pesos

Amount in Dollars agreed to be paid for Pesos bought in forward = 1,100,000/5.45 = $201834.86

If there was no forward contract , amount in dollars to be paid = 1100000/5.25 = $209523.81

So, U.S. dollars the firm saved by eliminating its foreign exchange currency risk with its forward market hedge

= $209523.81 - $201834.86

= $7688.95