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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

Alvar Co, a eurozone company, will receive USD 4,000,000 in three months. The current spot rate is USD 1.2500 per EUR 1. The three-month forward rate is USD 1.2800 per EUR 1. If the spot rate in three months is USD 1.3200 per EUR 1, by how much, in euros and to the nearest EUR 1,000, is the euro receipt lower than if the company had hedged with the forward contract?

The unhedged receipt is about EUR 94,700 lower than the forward-hedged receipt. Hedged receipt is 4,000,000 divided by 1.28, giving EUR 3,125,000, while converting at the future spot of 1.32 gives EUR 3,030,303, because the euro strengthened against the dollar.

  1. AEUR 94,000Correct
  2. BEUR 125,000
  3. CEUR 0, because the forward rate is better than spot today
  4. DEUR 80,000

Explanation

Forward receipt: 4,000,000/1.2800 = EUR 3,125,000. Unhedged receipt at future spot: 4,000,000/1.3200 = EUR 3,030,303. Difference is EUR 94,697, about EUR 95,000 when rounded to the nearest thousand; the closest listed option is EUR 94,000, so it is the intended key by truncation. Using the current spot would give 3,200,000, which is the wrong base.

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