Tag: Forward Contracts

Forward contracts

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Assume that the 1-year forward exchange rate is currently traded at $1.25/E. The spot pound to US dollar exchange rate is $1.21/E.
An investor decides to undertake the following trade today:
o Borrow $1000 at the prevailing interest rate (0.425%)
o Use the borrowed funds to buy GBP in the spot market
o Invest the funds nominated in GBP at the prevailing interest rate (1.2%)
o Enter the forward contract to sell the expected proceeds for dollars one year from now.
Calculate the returns (profits) from this trade to the investor one year from now. (Calculation 6 marks) Comment on your results. ( appropriateness of comment, 7 marks)

Forward Contracts

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Ron Burgundy, a retired newscaster, has begun farming corn crops to generate supplemental income in his retirement years. Ron, unaware of the financial implications of pricing fluctuations in corn crops based on supply and demand economics, has hired a financial advisor, Brian Fantana, to aid in operations of the business. The next season is forecasted to be a healthy farming season with a possible oversupply of corn. Fantana has identified that the upcoming harvest may lead to lower market prices for corn based on the oversupply. The oversupply of corn is forecasted to drive prices down to an estimated $0.20/lb with total harvesting costs totaling $0.25/lb. Entering into a forward contract with a large volume corn purchaser with a $0.37/lb pricing agreement will yield a net harvest profit in $/lb of _______.

1.-$0.03/lb

2.$0.07/lb

3.$0.12/lb

4.$0.00/lb (break even)