In: Finance
A Canadian importer has ordered $2,000,000 US worth of customized Microsoft Office 365 to be delivered in six months. The current spot exchange rate is $1.50 CAD = $1.00 USD. However, the importer fears that the Canadian dollar (CAD) will depreciate to $1.55 CAD = $1.00 USD in the next 6 months. As a result, the importer purchases $1,000,000 USD at today’s prevailing six-month forward rate of $1.52 CAD = $1.00 USD. What is the savings to the importer from his dealings in the forward market(assume his fears comes true in the next 6 months)? (a) $60,000 USD. (b) $60,000 CAD. (c) $100,000 CAD. (d) $40,000 CAD.
A Canadian importer has ordered $2,000,000 US worth of customized Microsoft Office 365 to be delivered in six months.
Therefore amount required in six months = $2,000,000 USD
The current spot exchange rate is $1.50 CAD = $1.00 USD.
However, the importer fears that the Canadian dollar (CAD) will depreciate to $1.55 CAD = $1.00 USD in the next 6 months. If it depreciates, then
The amount required in CAD in six months = $2,000,000 USD * expected exchange rate in six month
= $2,000,000 USD * ($1.55 CAD/ $1.00 USD) = $3,100,000 CAD
If importer enters into forward contract with today’s prevailing six-month forward rate of $1.52 CAD = $1.00 USD
The amount required in CAD = the required payment * six-month CAD/USD forward rate
Where,
The required payment = $2,000,000 USD
Today’s prevailing six-month forward rate = $1.52 CAD = $1.00 USD
Therefore,
Amount required in Canadian dollars = $2,000,000 USD * ($1.52 CAD/ $1.00 USD) = $3,040,000 CAD
The savings to the importer from his dealings in the forward markets
= $3,100,000 CAD - $3,040,000 CAD
= $60,000 CAD
Therefore correct answer is option (b) $60,000 CAD