Question

Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows:

The U.S. one-year interest rate:		6.10	% per annum
The euro zone one-year interest rate:		9.00	% per annum
The spot exchange rate:	$	1.50	/€
The one-year forward exchange rate	$	1.46	/€

Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Suppose that on the maturity date of the forward contract, the spot rate turns out to be $1.40/€ (i.e. less than the forward rate of $1.46/€). Which of the following is true?

A) Boeing gained $0.6 million from forward hedging.

B) Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract. Additionally, Boeing gained $0.6 million from forward hedging.

C) Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract.

D) none of the options

Answer 1

Boeing is entitled to receive 10 million Euro at the end of the year. However, in order to protect against fluctuation, it sells 10 million Euro worth of forward contract at the rate of $1.46 per Euro, receiving $14.6 million. At the end of the year, It buys back the contract at the prevailing spot rate of $1.4 per Euro, thus netting $0.6 million in hedging profit. However, the proceeds from Lufthansa will also amount to $14 million instead of $15 million, if it had received the money on spot basis. So overall, it reduced its loss from $1 million to $0.4 million ($1 million-$0.6 million)