2. Suppose a U.S. company contracted to sell 10,000 units of a product to a Fren

Question

2. Suppose a U.S. company contracted to sell 10,000 units of a product to a French company at a unit sales price of €3 with delivery in 120 days and payment due on delivery. The nominal exchange rate between U.S. dollar and Euro is 1.2 $/€ on the contract signing date. The U.S. company has the option of using a 120-day forward contract to protect itself against an adverse change in the exchange rate. Based on the assessment of the financial markets, the 120-day forward contract can be purchased at a discount of 4%.

a. If the nominal exchange rate between U.S. dollar and Euro decreases to 1.15 $/€ on the delivery date, how much will the U.S. company receive in terms of U.S. dollar on the delivery date? Please provide at least one step of calculation for full credit. (4 points)

b. If the U.S. company chooses to use the 120-day forward contact to protect against the foreign exchange risk, how much will the U.S. company receive in terms of U.S. dollar on the delivery date? Please provide the correct forward rate and at least one step of calculation for full credit.

Explanation / Answer

the total payment in US dollars as on today based on 4 month contract price= 10,000*3*1.2= $36,000

a. on the delivery date if the dollar exchange rate with Euro is 1.15, then the payment is= 10,000*3*1.15= $34,500

b. if it enters into forward contract on agreement date, its benefit is $36,000- 34500= $1500

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