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Gray research sold a supercomputer to Maz Pank Institute in Germany on credit and invoiced 10...

Gray research sold a supercomputer to Maz Pank Institute in Germany on credit and invoiced 10 million euros payable in 6 months. Currently, the six-month forward exchange rate is $1.10/Euro and the foreign exchange advisor is for Gray research predicts the spot rate will likely be $1.05/Euro in six months.

A. What is the expected gain/loss from a forward hedge?

B. If you were the financial manager of Gray research would you recommend hedging this euro receivable? Why?

C. Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you recommend hedging in this case? Why?

D. Suppose now that the future spot exchange rate is forecast to be $1.17/Euro. Would you recommend hedging? Why?

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Answer #1

A.Expected Gain/Loss from forward hedge = (1.10-1.05)*10,000,000

= $500,000

Hence, a gain of $500,000

B.Yes, I would recommend hedging since the expected spot rate is lower than the forward rate

C.Yes, I would recommend hedging. Since the expected spot rate is same as forward rate, it is better to lock in the exchange rate today itself.

D.No, I would not recommend hedging. Since the actual spot rate is higher, it will lead to higher profits.

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