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On May 6, 2013, the treasurer of a corporation enters into a long forward contract to...

On May 6, 2013, the treasurer of a corporation enters into a long forward contract to buy £1 million in six months at an exchange rate of 1.5532

This obligates the corporation to pay $1,553,200 for £1 million on November 6, 2013

What are the possible outcomes?

Solutions

Expert Solution

There are 3 possible outcomes.

1. spot exchange rate on November 6, 2013 is lower than forward exchange rate 1.5532.

2. spot exchange rate on November 6, 2013 is higher than forward exchange rate 1.5532.

3. spot exchange rate on November 6, 2013 is equal to forward exchange rate 1.5532.

in 1st outcome, let's say exchange rate on November 6, 2013 is 1.5512.

in this case corporation will incur a loss because they have to pay $1,553,200 for £1 million whereas in the spot market they can bought £1 million by paying $1,551,200 (£1 million*1.5512). so they will incur loss of $2,000 ($1,553,200 - $1,551,200).

in 2nd outcome, let's say exchange rate on November 6, 2013 is 1.5552.

in this case corporation will have a profit because they have to pay $1,553,200 for £1 million whereas in the spot market they can bought £1 million by paying $1,555,200 (£1 million*1.5552). so they will have profit of $2,000 ($1,555,200 - $1,553,200).

in 3rd outcome, corporation will neither have profit nor loss because forward rate and spot exchange rate on November 6, 2013 will be the same.

jeff jeffy answered 4 months ago
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