Question

The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. You enter into a long position on €1,000. At maturity, the spot exchange rate is $1.40/€. How much have you made or lost? Group of answer choices +$100 -$100 -$50 +$50

Answer 1

Solution:

As per the information given in the question we have

The position taken is long Position. This implies that currency will be purchased.

The amount of currency to be purchased = € 1,000

The three month forward rate = $ 1.50/€

This implies Exchange rate is 1 € = $ 1.50

At maturity, the spot exchange rate is = $ 1.40/€

This implies Exchange rate is 1 € = $ 1.40

Calculation of amount of dollars that will be spent, if € 1,000 is purchased under a three month forward :

As per the information given in the question we have

The amount of currency to be purchased = € 1,000

The three month forward rate = $ 1.50/€

This implies Exchange rate is 1 € = $ 1.50

Thus dollar cost of purchasing € 1,000 = € 1,000 * Exchange rate

= € 1,000 * $ 1.50

= $ 1,500             

Thus the dollar cost of purchasing € 1,000 in the forward market = $ 1,500           

Calculation of amount dollars that will be spent, if € 1,000 is purchased at maturity at the spot market rate:

As per the information given in the question we have

The amount of currency to be purchased = € 1,000

The spot market exchange rate at maturity = $ 1.40/€

This implies Exchange rate is 1 € = $ 1.40

Thus dollar cost of purchasing € 1,000 = € 1,000 * Exchange rate

= € 1,000 * $ 1.40

= $ 1,400             

Thus the dollar cost of purchasing € 1,000 in the spot market at maturity = $ 1,400

Calculation of amount made or lost :

Since the dollar cost of purchasing € 1,000 in the spot market at maturity is less than that of purchasing under a forward, the amount lost is

= dollar cost of purchasing € 1,000 in the spot market at maturity - dollar cost of purchasing € 1,000 under a forward

= $ 1,400 - $ 1,500

= - $ 100

The amount lost under the forward contract = - $ 100

Thus the solution is Option 2 = - $ 100