Question

Forward hedging: As exporter to UK, you will receive 100,000 GBP in 3-months. If the 3-month forward rate is 1.24 USD / GBP, describe your hedging strategy with this forward contract. How many USD will you receive by using the hedging strategy? If 3-months from now the spot rate is 1.20 USD/GBP, by using the forward contract you have made an opportunity gain/loss of how many USD? (5 points) Hedging strategy and payment in USD: Opportunity gain/loss calculation and answer:

Answer 1

facts of the case,

Amount required to be paid after 3 months by the US importer to the UK exporter = GBP 100,000

3 months forward rate = 1.24USD/GBP

Hedging strategy would be to buy forward contract to buy GBP 100,000 at 1.24 USD/GBP

Amount that will be paid by using hedging strategy in USD = 100,000*1.24 = USD 124,000

Amount that will be paid without hedging at spot rate in USD = 100,000*1.20 = USD 120,000

Opportunity loss by using the forward contract = USD 124,000- USD 120,000= USD 4,000

Forward hedging is a tool used to shield against unfavorable changes in the exchange rates between currencies.An importer who needs foreign currency to settle import obligations by entering into forward contracts,option contracts or contract for currency swaps.Each of these modes has its own costs,risks and benefits.