1.Suppose the spot rate of the pound today is $1.70 and the three-mont

QUESTION

1.Suppose the spot rate of the pound today is $1.70 and the three-month forward rate is $1.75.
a. How can a U.S. importer who has to pay 20,000 pounds in three months hedge her foreign- exchange risk?
b. What occurs if the U.S. importer does not hedge and the spot rate of the pound in three months is $1.80?
a) US importer can take the forward cover for his pound requirements due in three months. Accordingly by doing this importer will freeze his liability at exchange rate of $1.75 and he will have to shell out dollars at due date = 20000*1.75 = $35,000. b) If US importer doesnt hedge his position then he¦

will have to purchase the dollars at the prevailing spot rate of Pound/dollar and in this case he will have to shell out dollar = 20000*1.80 = $36,000 So he will loose $1000 by not hedging his position.

ANSWER:

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