Suppose an auto manufacturer in Michigan enters into a forward contract with a local distributor of...

Suppose an auto manufacturer in Michigan enters into a forward contract with a local distributor of auto parts for the purchase of 100,000 crankshafts at a price of $200. (5 pts.) a) What will happen on the delivery date?

b) What is the possible benefit to each party (the auto manufacturer and the auto parts distributor) under this contract?

c) Suppose on the delivery date the spot price turns out to be $250. Would the auto parts distributor still benefit from entering into such a forward contract? Why or why not?

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Expert Solution

Answer:

(a) The auto manufacturer has entered into a forward contract with the local distributor to purchase 100,000 parts at $200.
So, on the delivery date the auto manufacturer will pay $(100,000*200) i.e. $20,000,000

(b) The auto-manufacturer has hedged himself against the risk of spot rate increasing on the delivery date. In case, the spot rate on the delivery date gets more than the decided forward rate, it will be benefit the manufacturer. On the other hand, if the spot rate on the delivery rate gets decreased, it will benefit the distributor as he will get more against the spot rate on the delivery date.

(c) Suppose on the delivery date the spot price turns out to be $250 then the auto distributor will bear the loss of ($250-$200)*100,000 = $5,000,000 in total which is a benefit to the auto manufacturer.

jeff jeffy answered 1 year ago

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