Question

Suppose you need to pay V = 50,000 GBP in a year from now. Spot rate of GBP is 1.3. You do not have enough USD to purchase 50,000 GBP right now. Depending on the state of economy, the GBP spot rate in a year from nom may be:

Favorable state: 1.2; Neutral state: 1.3; Unfavorable state: 1.4

Calculate the payoff of hedging with forward contracts for each of the three states assume the futures premium = 0.03

Answer 1

Forward Rate = Spot rate + Future premium = 1.3 + 0.03 = $ 1.33/ GBP

Condition	Time	Amount in GBP	Exchnage rate		Amount in $		Forward contract Exchange rate		Amount in $ In forward Contract		Hedge : Profit /LOSS
	0	GBP 50,000	1.3	50,000*1.3=	$65,000
Favorable State		GBP 50,000	1.2	50,000*1.2=	$60,000		1.33	50,000*1.33=	$66,500	66,500-60,000=	$6,500
Neutral State		GBP 50,000	1.3	50,000*1.3=	$65,000		1.33	50,000*1.33=	$66,500	66,500-65,000=	$1,500
Unfavorable State		GBP 50,000	1.4	50,000*1.4=	$70,000		1.33	50,000*1.33=	$66,500	66,500-70,000=	($3,500)