Question

CH:17:

3. Trading in foreign exchange

A: What are spot rates and forward rates?

Lost Pigeon Aviation, a U.S. company, produces and exports industrial machinery overseas. It recently made a sale to a Japanese manufacturing firm for ¥625 million, but the Japanese firm has 60 days before it must make the payment to Lost Pigeon Aviation The spot exchange rate is ¥130.11 per dollar, and the 60-day forward rate is ¥133.78 per dollar. Is the yen selling at a premium or at a discount in the forward market relative to the U.S. dollar?

___In the forward market, the yen is trading at a premium.

___The yen is trading at a discount in the forward market.

B: If the customer pays Lost Pigeon Aviation the ¥625 million today, how much will Lost Pigeon Aviation receive in dollars?

___$4.80 million

___$5.52 million

___$6.00 million

___$4.08 million

C: Assuming that the forward market is correct and the spot exchange rate in 60 days will equal the 60-day forward exchange rate today, Lost Pigeon Aviation would get more dollars if the Japanese firm paid off its account (CHOOSE ONE: TODAY or IN 60 DAYS) .

Answer 1

A]

Spot rate is the current exchange rate. It is the exchange rate that would be applicable if the currencies are exchanged today.

Forward exchange rate is the exchange rate that would be applicable on a forward contract. A forward contract is an agreement to exchange a specified currency for another on a specified date and at a specified rate. The specified rate is called the forward exchange rate

It takes more yen to buy each dollar in the future than now. Hence, the dollar is trading at a premium in the forward market.

If one currency is at a premium, the other currency is at a discount.

The yen is trading at a discount in the forward market

B]

Dollars received = yen amount / spot exchange rate

Dollars received = ¥625,000,000 / 130.11

Dollars received = $4.80 million

C]

Dollars received after 60 days = yen amount / forward exchange rate

Dollars received after 60 days = ¥625,000,000 / 133.78

Dollars received after 60 days = $4.67 million

Lost Pigeon Aviation would get more dollars if the Japanese firm paid off its account today