Question

A French company is importing some equipment from Switzerland and will need to pay 10 million Swiss francs three months from now. Suppose that the current spot exchange rate is, S(CHF/EUR) = 1.5543. The treasurer of the company expects the Swiss franc to appreciate in the next few weeks and is concerned about it. The three-month forward rate is F(CHF/EUR) = 1.5320. Given the treasurer’s expectation, what action can he take using the forward contract? Three months later, the spot rate turns out to be S(CHF/EUR) = 1.5101. Did the company benefit because of the treasurer’s action?

Answer 1

Ans : Three months from now the treasurer expects swiss franc to appreciate against euro.

This means that 3 months from now, when the french company will settle the liability it will have to pay more Euro to buy swiss francs if swiss franc appreciates.
Thus in order to hedge against the foreign exchange risk the treasurer can enter into three-month forward contract to sell 6.53 million euros (10 milion / 1.5320)   @ CHF / EUR = 1.5320.

At 3 months the spot rate turn out to be CHF/EUR = 1.5101

If the treasurer would have not entered into a forward contract it would have paid Euro 6,622,078.01(10 million / 1.5101) @ spot rate of CHF/EUR = 1.5101 for 10 million swiss franc.

However since it entered into forward contract it had to pay Euro 6,527,415.14 (10 million / 1.5320) for 10 million swiss franc.

Thus the company did benefit from treasury's action since it saved 94,662.87 Euros by entering into forward contract.