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

Dunmore Co, a company with a euro functional currency, expects to receive GBP 2,000,000 in two months and to pay GBP 1,200,000 in two months, both from the same UK customer and supplier. Spot is GBP 0.8500 per EUR 1 and the two-month forward is GBP 0.8600 per EUR 1. The company hedges only its net exposure with a forward contract. What is the euro value locked in by the hedge?

The hedge locks in EUR 930,233. The company nets its sterling flows to a GBP 800,000 receipt and sells that forward at GBP 0.86 per euro, so 800,000 divided by 0.86 gives about EUR 930,233.

  1. AEUR 930,233Correct
  2. BEUR 1,395,349
  3. CEUR 2,352,941
  4. DEUR 941,176

Explanation

Net exposure is a GBP 800,000 receipt (2,000,000 less 1,200,000). Converting at the forward rate: 800,000/0.8600 = EUR 930,233. Using spot gives EUR 941,176, which is the wrong rate. Hedging only the receipt would give EUR 2,325,581.

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