In 1996,DEC hedges a FF 3.2 million receivable due in 180 days.The current spot rate is FF 1 = $0.18834 and the 180-day forward rate is FF 1 = $0.18625.If the spot rate at the end of 180 days is $0.18728,how much has the forward market hedge cost DEC?
A)$6,688
B)$3,392
C)$3,296
D)DEC gains $6,688 on the hedge

Question

Quizplus · Accepted Answer

To calculate the cost of the forward market hedge, we need to compare the payoffs of the hedge and not hedging.

Not hedging:
If DEC doesn't hedge, then it will receive FF 3,200,000 * $0.18834 = $603,648 in 180 days.

Hedging:
DEC hedges the receivable with a forward contract at FF 1 = $0.18625. So, it locks in the receipt of $3,200,000 * $0.18625 = $596,000 in 180 days.

However, the spot rate at the end of 180 days is $0.18728, which means that if DEC didn't hedge, it would have received FF 3,200,000 * $0.18728 = $599,296. This is better than the hedged amount of $596,000.

Therefore, the cost of the forward market hedge is the difference between what DEC actually received and what it would have received if it didn't hedge: $599,296 - $596,000 = $3,296, which is option C.

In 1996,DEC Hedges a FF 3