Answer-first summary for fast verification
Answer: EUR 7,401
## Explanation **B is correct.** The net benefit of hedging is calculated by comparing the EUR amount received under the forward contract versus the spot conversion. ### Forward Contract Calculation: - The firm is receiving USD, so they will sell USD and buy EUR - When selling USD, they use the bank's bid price (the rate at which the bank buys USD) - Forward bid price = 1.2020 USD/EUR (bank buys USD at this rate) - EUR received via forward = USD 1,100,000 / 1.2020 = EUR 915,141.43 ### Spot Conversion Calculation: - If unhedged, they would convert USD to EUR at the future spot rate - When selling USD, they use the bank's bid price - Spot bid price = 1.2118 USD/EUR (bank buys USD at this rate) - EUR received via spot = USD 1,100,000 / 1.2118 = EUR 907,740.55 ### Net Benefit: - EUR 915,141.43 (forward) - EUR 907,740.55 (spot) = EUR 7,400.88 ≈ EUR 7,401 **Why other options are incorrect:** - **A (EUR 7,176):** Uses forward ask price (1.2015) and spot bid price (1.2118) - **C (EUR 7,557):** Uses forward bid price (1.2020) and spot ask price (1.2115) - **D (EUR 7,782):** Uses forward ask price (1.2015) and spot ask price (1.2115) The key is to use the correct bid/ask prices based on the direction of the transaction - when selling USD, use the bank's bid price for both forward and spot calculations.
Author: LeetQuiz .
Ultimate access to all questions.
The treasurer of a large Belgian industrial firm wants to hedge an expected incoming cashflow of USD 1,100,000, which will be occurring 1 year from now. The treasurer receives a quote from an American bank for a 1-year forward contract at 1.2015 / 1.2020 USD per EUR. The treasurer then runs several scenarios comparing the financial impact of hedging the exposure to remaining unhedged and converting the cashflow at the prevailing spot exchange rate 1 year from now. Assuming no transaction costs, if the final exchange rate 1 year from now is quoted at 1.2115 / 1.2118, what is the best estimate of the net benefit to the firm from hedging the exposure?
A
EUR 7,176
B
EUR 7,401
C
EUR 7,557
D
EUR 7,782
No comments yet.