Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware

Question

Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.618 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure? Please show your calculations step by step. Thanks

Explanation / Answer

Step 1: Calculate Cost of Forward Contract (in Dollars)

The cost of forward contract can be calculated with the use of following formula:

Cost of Forward Contract = Purchase Value in Swiss Francs/90 Days Forward Rate

Using the values provided in the question, we get,

Cost of Forward Contract = 39,960/1.682 = $23,757.43

_________

Step 2: Calculate Cost of Exchange Currency at the 90 Days Spot Rate

The cost of purchasing exchange currency at the spot rate in 90 days can be calculated with the use of following formula:

Cost of Purchasing Exchange Currency = Purchase Value in Swiss Francs/90 Days Spot Rate

Using the values provided in the question, we get,

Cost of Exchange Currency = 39,960/1.618 = $24,697.16

_________

Step 2: Calculate the Savings from Hedge

The amount of savings can be calculated with the use of following formula:

Savings = Cost of Exchange Currency (Step 2) - Cost of Forward Contract (Step 1) = 24,697.16 - 23,757.43 = $939.73 or $940

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