Question
A company based in the United States is expecting to
receive a payment of 10 million euros in next two months. The company is concerned about the fall in the value of euros and is thinking of entering into a forward contract to hedge the position. What will be the value of 10 million euros in US dollars, if the company hedges the position of exchange rate risk with a forward contract of 1.18 USD/EUROSolution
The company has hedged its currency exchange rate risk by entering into a forward contract at a future date (two months). The value of the amount it will receive will be = Amount of Euro x forward rate = 10 million EURO * 1.18 (USD/EURO) = 11.8 million USD. The company will receive 11.8 million USD. This eliminates exchange rate risk because the company now knows exactly how many dollars it will have, providing certainty for its financial planning and protecting it against a potential fall in the value of euros.
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