Your company is exporting a product to S. Korea. The sale price is 160,000,000 w

Question

Your company is exporting a product to S. Korea. The sale price is 160,000,000 won. It is to be paid in one year. The Current spot rate is 800 won to the dollar. The forward won sells at a discount of 12%; but your staff believes that the won will drop 9% over the next year.

If you buy a forward contract today, what will be your U.S. proceeds when the contract comes due?

NOTE: IN THIS PROBLEM, PLEASE BE SURE TO CONVERT TO U.S. DOLLARS PRIOR TO CALCULATING THE PROBLEM. IN OTHER WORDS -- USE THE US DOLLAR RECIPROCAL FOR THE SPOT AND FORWARD RATES AS WELL AS THE FORECASTED RATE.

Using the above information, if you could borrow from a Seoul Bank at 20% per annum aganist the expected future proceeds, what would you receive in the U.S. dollars, and when.

Explanation / Answer

Current spot rate=1/800 USD/won=0.00125 USD/won

forward rate= (1-12%)*0.00125 USD/won=0.88*0.00125 USD/won=0.0011 USD/won

company enter the forward to sell the won at the forward rate of 0.0011 USD/won therefore the U.S. proceeds when the contract comes due= (160,000,000 won)*(0.0011 USD/won )=176,000 USD.

You borrow (160,000,000/1.20)won from a Seoul Bank at 20% per annum for 1 year and convert it into (160,000,000/1.20)*0.00125 USD at current spot rate to get USD 166,666.67 today and payback loan taken from bank 160,000,000 with the money received after 1 year.

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