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

Bramley plc (UK) will receive US$2,400,000 in 6 months. Spot is US$1.5000/£ and the 6-month forward rate is US$1.5200/£. What sterling amount does a forward contract fix for the receipt?

The forward contract fixes the sterling receipt at £1,578,947. The dollar amount is converted at the 6-month forward rate of 1.5200 by dividing 2,400,000 by 1.52. Using the spot rate would ignore that the forward contract locks in the forward rate.

  1. A£1,578,947Correct
  2. B£1,600,000
  3. C£1,615,000
  4. D£1,579,000 less forward premium

Explanation

A US$ receipt is converted into sterling by dividing by the forward rate: 2,400,000 / 1.5200 = £1,578,947. Using the spot rate gives £1,600,000, which is wrong because the forward contract locks in the forward rate, not spot. Multiplying instead of dividing would be a currency-direction error.

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