optiix

An agreement that requires the parties to exchange a certain amount of Yen for a certain amount of Euros on a specific date in the future is called a(n):

A) exchange rate agreement.

B) currency forward contract.

C) foreign exchange future.

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Such an agreement is called a currency forward contract.

optiix

Which of the following statements regarding currency forward contracts is least accurate?

A) A long position in a currency that appreciates more than expected over the term of the contract will have a positive value at contract expiration.

B) If the domestic currency appreciates over the term of the contract, the party that is long the foreign currency will have losses on the contract.

C) Currency forward contracts can be settled in cash or by delivery.

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The forward exchange rate in the contract will reflect the expected appreciation or depreciation of the currency. If a currency appreciates by more than the expected appreciation implicit in the forward exchange rate, the party that is long that currency will have gains. An appreciation of one currency does not equate to gains to the party that is long that currency; if it appreciates by less than the appreciation reflected in the forward exchange rate, the long will have losses.

optiix

Macklin Metals has received 80 million pounds sterling. The company plans to spend $120 million on a project in the United States in 90 days. Macklin inters into a cash settlement currency forward to exchange the pounds for U.S. dollars at a rate of $1.50 per pound in 90 days. If the exchange rate is $1.61 per pound at the settlement date, the cash settlement Macklin will pay or receive is closest to:

A) $8.8 million payment.

B) $8.8 million receipt.

C) $5.5 million payment.

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Under the contract, Macklin receives:
80 million pounds × $1.50 = $120.0 million
At market rates, Macklin would receive:
80 million pounds × $1.61 = $128.8 million
Macklin must pay the difference, $8.8 million ($128.8 million − $120 million), as the cash settlement to the counterparty.