Question

A trader believes that the euro will appreciate versus the yen. She wants to use a forward contract to potentially profit from her view. The spot rate is ¥0.10/€ and the forward rate is ¥0.08/€. Should she buy or sell a forward on euros? If the spot rate finished at ¥0.12/€ then calculate her profit/loss If the spot rate finished at ¥0.05/€ then calculate her profit/loss

Multiple Choice:

sell euros forward; -¥0.02/€ profit; ¥0.05/€ loss

sell euros forward; -¥0.02/€ loss; ¥0.05/€ profit

buy euros forward; ¥0.04/€ profit; -¥0.03/€ loss

sell euros forward; -¥0.04/€ loss; ¥0.03/€ profit

buy euros forward; ¥0.02/€ profit; -¥0.05/€ loss

Answer 1

Spot rate: 1 yen = 0.10 euro

Forward rate: 1 yen = 0.08 euro

Trader believes that euro will appreciate in 1 year. So 1 yen can be bought with fewer euros in future. So considering the forward quote, he should enter forward contract to sell 1 yen and receive 0.08 euros.

At expiration, if spot rate is 1 yen = 0.12 euro, then trader will sell 1 yen and receive 0.08 by obliging the forward contract and then square off his position by borrowing additional 0.04 euros to buy 1 yen with a loss of 0.04 euros.

If Spot at expiry is 1 yen =0.05 euro, then trader will oblige forward contract and sell 1 yen to receive 0.08 euro. Then will square off the position by buying 1 yen for 0.05 euros, with remaining amount of  0.03 euros as profit.

Answer: Sell euros forward; -0.04 loss; 0.03 profit