Question

1. ABC Corporation negotiated a forward contract to sell C$100,000 in one year at a forward rate of C$1=$0.80. On the delivery date, the spot rate was C$1=$0.83.
How much is the revenue ABC Corporation can get from the forward hedge?

What is the real cost of hedging receivables for this U.S. firm?

2. Given the following additional information
Future Spot rate   RCHr Prob.
0.78    -2000 0.20
0.81     1000 0.50
0.83     3000 0.30
What is the probability that the forward hedge will result in higher revenue than no hedge?

How much is E(RCHr)? Overall, is forward hedge preferred?

Answer 1

Answer 1:

Revenue from the forward hedge= C$ 100,000 * C$ 0.80/$= $ 80,000

Real cost of hedging= Revenue without hedging Less Revenue with hedging

= $(100,000 * 0.83) - $80,000 = $3000

Answer 2:

E(RCHr) = (-2000*0.20) + (1000*0.50) + (3000*0.30) = 1000

Probability that forward hedge will result in higher revenue than no hedge = Nil (Because the forward rate is greater than the expected future spot rates)

Revenue with hedge = E(RCHr) * 0.83 = 1000* 0.83 = $830

Revenue without hedge = (-2000*0.20*0.78) + (1000*0.50*0.81) + (3000*0.30*0.83) = $840

Overall hedge is not preferred coz expected revenue without hedge is greater than revenue with hedge.