You are hoarse from explaining to your supervisor that the cost, if any, of hedging exchange-rate risk can be thought of as an insurance premium to avoid surprises.What is the cost of hedging a DM2 million commitment if the spot rate is DM1.6/$, the forward rate is DM1.55/$, and the expected spot rate at the end of the hedge is DM1.6/$?
A)$0
B)$25,000
C)$40,323
D)$68,966 current Dollar commitment =

Question

Quizplus · Accepted Answer

The cost of hedging can be calculated as the difference between the forward rate and the expected spot rate, multiplied by the amount of the commitment:

Cost of hedging = (forward rate - expected spot rate) x commitment
Cost of hedging = (DM1.55/$ - DM1.6/$) x DM2 million
Cost of hedging = -0.05 x DM2 million = -DM100,000

Since the result is negative, it means that the company will actually receive a gain of DM100,000 by hedging the exchange-rate risk. This is because the cost of the hedge is lower than the expected spot rate, so the company can lock in a lower exchange rate and avoid potential losses. Therefore, the answer is C) $40,323 (converted from DM100,000 at the given spot rate of DM1.6/$).

You Are Hoarse from Explaining to Your Supervisor That the Cost