Hey all,
New to the forum and new to forex. In final year college and have stayed on top of studies, however we’ve been given a question I can’t get my head around, despite its apparent simplicity.
Here it goes. This is from the point of view of a UK co. receiving payment from a U.S. firm, and you are trying to eliminate FX risk for the UK company.
“An American company will pay $3m in 3 months, show how FX risk can be eliminated using forward market and money market cover”
[B]The spread is $1.7680/£ - $1.7690/£ and the 3 month forward premium is 1.56 - 1.51[/B]
Interest Rates are 15/13% in London for Borrowing/Lending
Interest Rates are 10.5/8.5% in New York for Borrowing/Lending
My answer for the forward market cover part would be selling the $3m forward at the ask rate (discounting the premium) so [B]$3m/1.7539 = £1,710,473.80[/B]
have we essentially eliminated risk by guaranteeing we’ll receive less money in 3 months by ‘locking in’ in the future exchange rate of 1.7539? Do I find the cost of this transaction by subtracting the current spot ask rate from this figure? So £1,710,473.80 - £1,695,873.38 = £14,600.43
So because an American company doesn’t pay us now and pays us 3 months from now we take a not insubstantial hit, just to make sure that the risk of the dollar appreciating even more in that same 3 month period isn’t realized?