Question

Assume that Southern Co. negotiated a forward contract to purchase 100,000 British pounds in 90 days. The 90 day forward rate was $1.50 per British pound. The pounds to be purchased were to be used to purchase British supplies. On the day the pounds were delivered in accordance with the forward contract, the spot rate of the British pound was $1.54. What was the real cost or savings from hedging the payables for this U.S. firm? (4 Points)

Answer 1

Solution:

Amount = 100,000 British Pound

90 Day forward rate = $1.50 per British pound

So Southern Co will enter into the forard contract and buy 100,000 British Pound.

The spot rate after 90 days.= $1.54 per British pound

Since the forward rate is lower than the spot rate hence it means that Southern Co will be purchasing Pound at 1.50 per dollar. While the company had to purchase at 1.54 dollar per pound when they had to purchase from the spot market.

Hence the company made a profit of 1.54-1.50= 0.04 dollar per pound

Total Profit = 0.04 * 100,000 = $4000