Problem 11 page 659 Econ, forward rate hedge contract, interest, solution, forward, company

hanvinh

The treasurer’s action doesn’t look like it benefited the company. If he bought SF today at SF 1.5543/euro, he would have paid SF 10 million x (euro/SF 1.5543) = 6,433,764 euros.
In the solution, they say it was btter that he entered into the forward contract, through which he ended paying 6,527,000 euros.
The problem doesn’t look at interest rates.
If you have done this, can you correct me on it?

Analyze_This

Yes, if he buys SF now, he would lose interest on the euro (which is higher as implied by the forward contract). So, then he didn’t really benefit from the forward contract in this example, sinc the spot rae turned out to be SF 1.5101! It is clear that this is better than waiting 3 moths and then paying the spot rate, but what isn’t clear is whether buying SF today would have resulted in the same outcome as the forward contract.

dirk01

if you bought at spot and financed cash flow using the same interest rates as Forward fx rate implied, you would end with the same result as using FX forward contract directly.
this is the basic principle of pricing forward rates.