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Mini-Case: Use of Foreign Exchange Markets Each month, the O'Hare Sports Export Company (a U.S. firm...

Mini-Case: Use of Foreign Exchange Markets

Each month, the O'Hare Sports Export Company (a U.S. firm based in Newport, RI) receives an order for footballs from a British Sporting Goods distributor. The monthly payment for the footballs is denominated in British pounds, as requested by the British distributor. John Novack, owner of the O'Hare Sports Export Company, must convert the pounds received into dollars.

Questions to answer:

1. Define the spot market.

2. Explain how the O'Hare Sports Export Company could use the spot market to facilitate the exchange of currencies. Be specific.

3. Define the forward market.

4. Explain how the O'Hare Sports Export Company is exposed to exchange rate risk and how it could use the forward market to hedge this risk.

*Please answer in DETAIL, thank you!*

Solutions

Expert Solution

1) Spot market is a financial market where financial instruments, securities and commodities are traded for immediate delivery in cash.

2) In spot market buyer and seller creates spot price by posting their buy and sell orders. Spot market transactions can take place on an exchange or over the counter. Spot market transactions have T + 2 settlement date. T + 2 means O'Hare sports will get dollar in 2 working days in exchange of pound.

3) Forward market is over the counter financial markets by which contracts for future delivery are entered into. Forward market leads to creation of forward contracts. Prices in the forward market are interest rate based. Forward contracts sates a fixed price and date for future delivery of assets or financial instruments.

4) O'Hare Sports is required to sign forward contract with a bank at agreed rate for future delivery of dollar exchange to hedge the risk under forward markets. If price goes up or down in future company will receive the same amount of dollars in future date. So, this eliminates the risk of losses.

jeff jeffy answered 1 year ago
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