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Question #5. After studying Chapter 26, we understand that futures and forwards can be used to...

Question #5.

After studying Chapter 26, we understand that futures and forwards can be used to reduce risk. What are the differences between futures and forwards?

A Canadian firm will have to pay US $1 million six months from now for the goods purchased from a US company. In light of the COVID-19 pandemic, the company is concerned about potential increases in the value of the US dollar in the future. How could this firm hedge against this risk with forwards?

Forward contract quotations (CAD/USD)

period	price
1 month	1.37374
3 month	1.37510
6 month	1.37765
9 month	1.38052

Expert Solution

Solution :-

The Difference between Forward Contract and Futures are that :-

1. Future Contract are Standardised means regularly trade and forward contract are customised generally do with the banks

2. In Future Contract initial margin termed as option premiums required while in forward contract no initial margin is required .

3. Future Options are settled on maturity date while forward contract settled on a daily basis

4. Futures are less costly as compared to forward contracts

Canadian firm need to pay after six months = US $ 1 million

Fear in Canadian Dollar that the value of USD not increase

So to hedge the situation Canadian Dollar will do forward contract of 6 months to buy US dollar

at the rate 1 USD = 1.37765 Canadian Dollar

After this at the time of payment Canadian firm buy $1,000,000 in CND = $1,000,000 * 1.37765 = CND 1,377,650

After this , if the exchange rate increase Canadian firm can do the payment will the help of forward contract

If there is any doubt please ask in comments

Thank you Please Rate....

jeff jeffy answered 1 year ago

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