Suppose Bimbo Bakery wants to expand its facilities in Guadalajara Mexico. It hi

Question

Suppose Bimbo Bakery wants to expand its facilities in Guadalajara Mexico. It hired Reading Bakery for its expansion and agreed to pay $2M upon completion. The contract was signed on May 15 and the work needs to be completed by Nov 15. Around August 15 tariff tension rose between Mexico and the US and due to uncertainty Reading Bakery decided not to pursue the project. The rate of MXP on May 15 was $.0015 and on August 15 it was $0.0012. How can Bimbo protect its funds if it has decided to negotiate a 6 month forward contract to obtain USD to pay Reading Bakery. Explain.

Explanation / Answer

Bimbo can protect its funds by entering a forward contract to buy USD using MXP at $0.0015 per MXP after 6 months. This will entail payment of less amount of dollars per MXP and would be beneficial for Bimbo. This shall protect Bimbo as it will not have to pay more MXP per dollar if the rates slide down.

At $0.0015 MXP required to pay 1 Dollar=1/0.0015=666.67 MXP
At $0.0012 MXP required to pay 1 Dollar=1/0.0012=833.33 MXP

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