1. ABC Corporation negotiated a forward contract to sell C$100,000 in one year a
ID: 2656999 • Letter: 1
Question
1. ABC Corporation negotiated a forward contract to sell C$100,000 in one year at a forward rate of C$1=$0.80. On the delivery date, the spot rate was C$1=$0.83.
How much is the revenue ABC Corporation can get from the forward hedge?
What is the real cost of hedging receivables for this U.S. firm?
2. Given the following additional information
Future Spot rate RCHr Prob.
0.78 -2000 0.20
0.81 1000 0.50
0.83 3000 0.30
What is the probability that the forward hedge will result in higher revenue than no hedge?
How much is E(RCHr)? Overall, is forward hedge preferred?
Explanation / Answer
Answer 1:
Revenue from the forward hedge= C$ 100,000 * C$ 0.80/$= $ 80,000
Real cost of hedging= Revenue without hedging Less Revenue with hedging
= $(100,000 * 0.83) - $80,000 = $3000
Answer 2:
E(RCHr) = (-2000*0.20) + (1000*0.50) + (3000*0.30) = 1000
Probability that forward hedge will result in higher revenue than no hedge = Nil (Because the forward rate is greater than the expected future spot rates)
Revenue with hedge = E(RCHr) * 0.83 = 1000* 0.83 = $830
Revenue without hedge = (-2000*0.20*0.78) + (1000*0.50*0.81) + (3000*0.30*0.83) = $840
Overall hedge is not preferred coz expected revenue without hedge is greater than revenue with hedge.
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