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

Calder plc will pay US$4,000,000 in three months. Spot is US$1.6000 per £1; the three-month forward is US$1.5900 per £1. Calder is considering a futures hedge but finds none; instead it considers leaving the exposure open. The finance director's forecast spot rate in three months is US$1.5500. Compared with the forward hedge, what is the expected sterling gain or loss from remaining unhedged if the forecast is correct?

Hedging by forward costs about £2,515,723, whereas paying at the forecast spot of 1.5500 costs about £2,580,645. Remaining unhedged would therefore be roughly £65,000 worse, a loss of about £64,000 as the nearest option.

  1. ALoss of about £64,000Correct
  2. BGain of about £64,000
  3. CLoss of about £6,000
  4. DGain of about £1,000

Explanation

Forward cost = 4,000,000/1.59 = £2,515,723. Unhedged cost at 1.55 = £2,580,645. Unhedged is £64,922 more expensive, a loss of about £65,000, which is nearest to £64,000 among the options. The sign is a loss because a lower US$ per £ rate means the dollar payment costs more pounds.

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