Question

Assume the following information: U.S. deposit rate for 1 year = 11% U.S. borrowing rate for 1 year = 12% Singapore deposit rate for 1 year = 8% Singapore borrowing rate for 1 year = 10% Singapore forward rate for 1 year = $0.40 Singapore spot rate = $0.39

3. Using the information above, if a US. Company expects to receive S$600,000 for exports sold to a Singapore company:

a. What will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a forward hedge?

b. If the spot rate for the Singapore dollar 1 year later is $0.48, was the forward hedge a good strategy? Why? (Show by computation to defend your answer)

Answer 1

Here, US Company expects to receive S$ 600,000 for exports sold to a Singapore Company.

US Deposit Rate for 1 Year = 11%

US Borrowing Rate for 1 Year = 12%

Singapore Deposit Rate for 1 Year = 8%

Singapore Borrowing Rate for 1 Year = 10%

Singapore Spot Rate = US$ 0.39 (i.e. S$ 1 = $ 0.39)

Singapore Forward Rate for 1 Year = US$ 0.40 (i.e. S$ 1 = $ 0.40)

(a) Calculate the approximate value of these exports in 1 Year in US$ given the firm executes a forward hedge:

Here, the firm executed the forward hedge i.e. firm will receive the amount as per the forward contract irrespective of the actual spot rate at that time. So, the firm will receive US$ 0.40 for every S$ 1, as per the forward contract.

So, Amount to be received = S$ 600,000 * US$ 0.40 = US$ 240,000.

(b) If the spot rate 1 Year later for the S$ 1 = US$ 0.48, was the forward hedge good strategy?

So, if the firm decides not to execute the forward hedge, the firm will receive the amount as per the spot rate at the future date on which amount is received from Singapore i.e. US$ 0.48 for every S$ 1, as per given in the question.

So, the Amount to be received = S$ 600,000 * US$ 0.48 = US $ 288,000.

From, the above calculation in (a) and (b) it is clear that taking forward hedge was not a good strategy as due to forward contract firm is receiving US$ 48,000 (i.e. US$ 288,000 - US$ 240,000) less than what it would have received if it had not taken forward contract.