Question

Nelson, Inc. hedges 50% of their translation exposure one calendar quarter in advance, and rolls the contracts when they mature. Currently 1^st quarter net income is projected to be 125 million Canadian dollars. The current spot rate is .98 US dollars per Canadian dollar, and the forward rate to March 31, 2011, the end of 1^st quarter, is .987 US dollars per Canadian dollar. On 3/31/2011 the spot rate is now 1.045 US dollars per Canadian dollar.

(a) Explain how you would put in place a hedge on 50% of the forecasted net income.

(b) On 3/31 what do you now need to do?

(c) What is your total translated net income from the Canadian subsidiary including the impact of the hedge on 3/31/2011?

Answer 1

Nalson, Inc hedges 50% of their transaction exposure one calendar quarter in advance, and rolls the contract when it matured.

Projected income during the quarter 125 million Canadian Dollars.

Current Spot Rate: 0.98 US$ = 1 Canadian Dollar.

Forward Rate: 0.987 US$ = 1 Canadian Dollar.

(a). So, if Nalson Inc wanna hedge its 50% position, it may enter into a forward contract for 50% of the Income receivable during the said Quarter @ 0.987 US$ per Canadian Dollar. And Balance 50% should be settled at spot 3/31/2011.

Forward Contract required to be enter for the amount of 50% of 125 million Canadian Dollars for the said hedge.

50% of 125 million = 62.5 million Canadian Dollar.

(b). On 3/31: Spot Rate 1.045 US$ per Canadian Dollar.

Forward Contract required to be execute for 62.5 million Canadian Dollar. @ 0.987 US$ per Canadian Dollar.

And 50 % of the Canadian Dollars should be converted at spot @ 1.045 US$ per Canadian Dollar.

(c). Total Net Income for the quarter in US$: 62.5 million x0.987 + 62.5 million x 1.045

= US$ 61.6875 million + US$ 65.3125 million

= US$ 127 million.