Suppose a U.S. firm buys $200,000 worth of television tubes from a Mexican manuf

Question

Suppose a U.S. firm buys $200,000 worth of television tubes from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U.S. deficit has caused the dollar to depreciate against the peso recently. The current exchange rate is 5.68 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S. dollar. How much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge? Do not round the intermediate calculations and round the final answer to the nearest cent.

Explanation / Answer

pesos required=200000*5.68=1136000
pesos to be paid if not hedged=1136000
dollars to be paid if not hedged=1136000/5.3=214339.6226

pesos bought in forward market=1136000
at forward expiry, gain=1136000*(1/5.3-1/5.45)=5899.255669 dollars

Hence, US firm saved $5899.255669 by eliminating its foreign exchange currency risk

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