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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

A US exporter will receive EUR 5,000,000 in three months and wants to remove exchange rate risk using a forward contract. Which outcome best describes the effect of the hedge?

A forward sale of euros locks in the dollar value of the receipt, removing uncertainty, but the exporter gives up any benefit if the euro strengthens. Keeping upside while limiting downside would require an option, which costs a premium.

  1. AIt locks in the USD value of the receipt but forgoes any gain if the euro strengthensCorrect
  2. BIt locks in the USD value and keeps the full benefit if the euro strengthens
  3. CIt eliminates counterparty risk and basis risk
  4. DIt increases the exporter's exposure to the euro because the position doubles

Explanation

A forward fixes the exchange rate, so the USD proceeds are certain. The exporter therefore gives up gains from euro appreciation, unlike an option. A forward does not remove counterparty risk and does not double the exposure; it offsets it.

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