If forward rate is $ 2.02/£ 1 then we should go for forward cover because in opt

Question

If forward rate is $ 2.02/£ 1 then we should go for forward cover because in option market, there will be cost of premium and in future there will be interest cost on margin. BUt, in forward cover,no such need. If 180 days forward rate is $ 2.02/£ 1 then we should go with forward rate in terms of hedging the risk od ewducing $ value against % Step-1: Sale $ in the spot market and collect £ 1000 Step-2: Sale £ in forward market for 180 days forward rate. Step-3: At th end of 180 days deliver £ 1000 and get $ 2020 Thus,we have an increment of $ 20 in the dollar value of today I WANT MORE DETAILED HOW YOU SOLVED $2020

Explanation / Answer

It is mentioned that forward rate is 1£ = 2.02$

Assume US exporter having $ as home currency exported certain goods, payment of which is received in £. Hence US exporter has to face a risk when $ appreciates over £.To hedge that risk, exporter enters into forward contract. Forward rate is 1£ = 2.02$, Exporter prefers forward cover because in option market, there will be cost of premium and in future there will be interest cost on margin.

The transactions entered into by the exporter are explained below:

Step-1: Sell goods and get £(sale amount = 1000£)

Step-2: Enter into a forward contract to sell 1000£ on a future date (Forward contact is for 180 days)

Step-3: At the end of forward contract i.e at the end of contract period, honour the contract at the agreed exchange rate 1£ = 2.02$,

Hence amount of $ for 1000£= 2.02$ per £ * 1000£

                                                    = 2020$

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