Suppose you make a pound 550,000 sale to a British customer who has 60 days to p

Question

Suppose you make a pound 550,000 sale to a British customer who has 60 days to pay you in cash. The customer will pay you in British pounds, but your company is based in the United States, so you are most concerned with the dollar value of the payment. If the customer pays you pound 550,000 today, how much is that worth in dollars? $1,023,065 $818,452 $1,125,372 $869,605 Assume that the forward market is correct and the 60-day forward exchange rate quoted in the newspaper today is the spot exchange rate 60 days from now. If the customer waits the full 60 days and pays you pound 550,000, how much have you lost(in dollar terms) due to exchange rate fluctuations? $5,784 $7,145 $5,104 $6,805

Explanation / Answer

Solution

Part 1

The British Pound is selling at a discount in the forward market…

Since in Spot Exchange Rate 1 Dollar can buy 0.5376 Pound and in 30 days forward exchange rate 1 dollar = 0.5412 Pounds (It means in forward market 1 dollar can buy 0.5412 Pounds means more pounds than spot market. In future market pound is getting weak because dollar can purchase more pounds)

Part 2

If the customer pays Pound 550,000 today, the applicable exchange rate is spot exchange rate which is 1 dollar = 0.5376 Pound

Equivalent dollar value of pound 550,000 = 550,000 / 0.5376 = US$ 1,023,065

Part 3

Equivalent dollar value of pound as on today (as calculated in part 2above) = $1,023,065

Equivalent dollar value of pounds at 60 days from now =550,000 / 0.5412= $1,016,260

Net Loss = $1,016,260 - $1,023,065 = $6,805

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