Question

Gransh 9. Forward hedge Please refer to Table 3 in the datafile. To hedge exposure from a receivable of 1min EUR due in 3 months, Ganado could enter into a forward position, thus fixing an effective exchange rate of EUR/USD a) long; 1.1919 b) short; 1.1919 C) short; 1.1911 d) long; 1.1911

Answer 1

The US firm has a receivable of 1 million EUR in 3-months time. This implies that the firm will have to sell these euros post receiving them. The firm will be at a loss if the euros price in $ (amount of $ required to purchase one euro) goes down in 3-months time as compared to now. Therefore, the firm will want to fix the $ selling price of the euro.

The aforementioned objective can be achieved by selling (going short) on a forward contract.

The price of the forward contract can be determined as described below:

Current Spot Price : Bid - Ask = 1.1823 - 1.1829 (where bid is the price at which a unit of euro will be sold and ask is the price at which a unit of euro will be bought).

3-month Forward Premium: Bid - Ask = 88 - 90

3- month Forward Rate: Bid Rate (sale price) = Current Bid Spot + 3-Month Bid Forward Premium (likewise for the ask side)

In the context given, the firm needs to sell euros and it would be able to do so at the bid price 3-months later.

3-Month Bid Forward Rate = 1.1823 + (88/10000) = $ 1.1911 / EUR

Hence, the firm will go short on a forward contract at a rate of $ 1.1911/EUR. Therefore, the correct option is (c)