Question

In: Finance

A Canadian importer has ordered $2,000,000 US worth of customized Microsoft Office 365 to be delivered...

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.

Solutions

Expert Solution

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


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