Answer:
a) The expected loss from the forward hedging = $432,900
b) No I wouldn’t recommend hedging the euro receivable based on the fact that the future spot rate is better off than the forward exchange rate.
c) No I wouldn’t because in any case whether you hedge or not there will be no difference.
Explanation:
Solution.
Forward Exchange Rate = $1.10/€, therefore the equivalent of €10 million receivable from Germany in 6-month time = €10 million / Forward exchange rate ($1.10) = $9,090,909
However, the 6 months spot rate is $1.05/€, therefore if we simply wait till 6 months we will receive €10 million / Forward spot rate ($1.05) = $9,523,809.
a) The expected loss from the forward hedging = $9,523,809 - $9,523,809 = $432,900
b) No I wouldn’t recommend hedging the euro receivable based on the fact that the future spot rate is better off than the forward exchange rate.
c) No I wouldn’t because in any case whether you hedge or not there will be no difference. You’ll just end up paying hedging fees which will impact on profits adversely.
However it is always advisable to hedge foreign exchange risks because predictions could differ from reality and adverse movements in exchange rates could carry significant financial consequences which may not be comparable to the hedging costs.
