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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

A US exporter will receive EUR 5,000,000 in three months. The current spot rate is USD 1.1000 per EUR and the three-month forward rate is USD 1.0900 per EUR. The firm sells the euros forward. At maturity the spot rate is USD 1.0500 per EUR. What is the USD amount the firm realizes from the hedged receivable, and how much better off is it than if it had been unhedged?

The firm locks in 5,000,000 x 1.09 = USD 5,450,000. Unhedged, it would receive 5,000,000 x 1.05 = USD 5,250,000. The forward hedge therefore leaves it USD 200,000 better off, because the euro depreciated by more than the forward discount implied.

  1. AUSD 5,450,000, which is USD 200,000 better than unhedgedCorrect
  2. BUSD 5,450,000, which is USD 50,000 better than unhedged
  3. CUSD 5,250,000, which is USD 200,000 better than unhedged
  4. DUSD 5,500,000, which is USD 250,000 better than unhedged

Explanation

Hedged proceeds = 5,000,000 x 1.0900 = USD 5,450,000. Unhedged proceeds = 5,000,000 x 1.0500 = USD 5,250,000. The difference is USD 200,000. The option giving USD 50,000 wrongly compares the hedge with the original spot rate of 1.10 using the wrong amounts, and USD 5,500,000 uses today's spot rate.

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