Question

4. When a known future cash outflow in a foreign currency is hedged by a company using a forward contract, there is no foreign exchange risk. When it is hedged using futures contracts, the daily settlement process does leave the company exposed to some risk. Explain the nature of this risk. In particular, consider whether the company is better off using a futures contract or a forward contract when 1. The value of the foreign currency falls rapidly during the life of the contract 2. The value of the foreign currency rises rapidly during the life of the contract 3. The value of the foreign currency first rises and then falls back to its initial value 4. The value of the foreign currency first falls and then rises back to its initial value Assume that the forward price equals the futures price.

Answer 1

Altogether the addition or misfortune under a prospects contract is equivalent to the increase or misfortune under the comparing forward contract. Anyway the planning of the money streams is extraordinary. Whenever the
time estimation of cash is considered a Future contract may end up being progressively profitable or on the other hand less significant than a forward contract. Obviously the organization does not know ahead of time which will work out better. The long forward contract gives an ideal fence. The long prospects contract gives a somewhat flawed support.

a) For this situation, the forward contract would prompt a somewhat better result. The organization will make a misfortune on its support. On the off chance that the fence is with a forward contract, the entire of the misfortune will be acknowledged toward the end. In the event that it is with a prospects contract, the misfortune will be acknowledged day by day all through the agreement. On a present esteem premise the previous is ideal.

b)For this situation, the prospects contract would prompt a marginally better result. The organization will make an increase on the support. On the off chance that the fence is with a forward contract, the increase will be acknowledged toward the end. In the event that it is with a fates contract, the increase will be acknowledged step by step for the duration of the life of the agreement. On a present esteem premise the last is ideal.

c) For this situation, the prospects contract would prompt a somewhat better result. This is on the grounds that it would include positive money streams early and negative money streams later.

d) For this situation, the forward contract would prompt a marginally better result. This is on the grounds that, on account of the prospects contract, the early money streams would be negative and the later income would be certain.