Question

A U.S. government agency located in Kuwait bought 29 standby power generators (including installation) from a trading company in Kuwait. The contract was effectively written in USD for $1,588,000 (worth 447,180.80 KWD) since the exchange rate of .2816 was fixed in the contract. The performance period was 90 days; however, the buyer expected complications such as material availability and security access passes from the host nation to delay contract performance. See attached excerpt from the contract. Assume payment terms were Net 30. Assume the Kuwaiti Dinar is a floating currency. The buyer was aware that the KWD had strengthened against the USD since 2003. Although Financial Management personnel informed the buyer that a hedging strategy would not be used, the buyer could see the 90-day currency exchange forward contracts indicating the exchange rate moving to USD/KWD = .265. From the buyer’s perspective, which currency should the contract have been written in had the exchange rate not been fixed in the contract? ______ What would be the financial advantage (expressed in USD) of doing so? _______

Answer 1

Answer: KWD; $99474 avoided

Explanation:

From the question, we're informed that the buyer was aware that the KWD had strengthened against the USD since 2003 coupled with the fact that KWD is a floating currency, it'll have been better if the contract was written in KWD as this will mean lesser money is paid.

Since 1 USD = 0.2816 KWD, and has been predicted to reduce to 1 USD = 0.265, the company would save:

= $1,588,000 × (0.2816-0.265)/0.265

= ($1,588,000 × 0.0166)/0.265

= $26360.8/0.265

= $ 99474