Question

Explain how the forward exchange rate can be used by a hedge fund for speculative purposes. Use realistic numerical examples to illustrate your answer, Use the dollar per euro exchange rate as the basis for your answer.

Answer 1

Currency Forward contract is a contract where by one party enter into transaction with another party to buy or sale one currency at a stated price for another currency on a specifid date .
Both party has to honer this agreement only on specific agreed date at the time of entering into forward contract .
Hedge fund can use forward rate agreement for speculative purpose. If hedge fund feels that particular currency is likely to appreciate compared to other currency they can buy forward contrat for currency likey to get appreciated . Lets take an example -
Example : Suppose H corporation is US based hedge fund and feel that Euro currency likey to be appreciated compared to USD after 6 month. Current spot rate is $1.5/Euro and 6 month forward rate is quating at $1.45/Euro. a) After 6 month Euro appreciated and spot rate is $1.8. b) after 6 month Euro depreciated and spot rate is $1.3
Hedge fund is feeling of Euro appreciation after 6 month and therefor will enter into forward contract to exchange $1million for Euro at 6 month forward rate of $1.45/Euro
Scenario a- Euro appreciated after 6 month
USD paid under forward contract	$      1,000,000
Hedge fund will receive euro of $1million/1.45	689,655	Euro
Convert this amount in USD in spot market at rate of $1.8/Euro	$      1,241,379
Gain on speculation = $1241379-$1000000	$         241,379	Gain on speculation
Scenario b- Euro depreciated after 6 month
USD paid under forward contract	$      1,000,000
Hedge fund will receive euro of $1million/1.45	689,655	Euro
Convert this amount in USD in spot market at rate of $1.3/Euro	$         896,552
Gain on speculation = $1241379-$1000000	$       (103,448)	Loss on speculation