Exercise Set 5.2
HEDGING IN THE FORWARD MARKET

I. Objectives

1. To understand how exporters and importers hedge against exchange-rate risk

II. Data

Boeing, a U.S. firm, manufactures a 747 jet at a cost of $1.70 million and sells it to British Airways, a U.K. firm, for 1.00 million pounds in March. The payment from British Airways is due 3 months later, in June.

• Spot rate: $1.7640/pound
• 3-month forward rate: $1.7540/pound

• Select a value for the (actual) spot rate that obtains in June (E_June).
• Compute Boeing's profit under various scenarios.

III. Questions

1. Suppose Boeing takes an unhedged position. Compute Boeing's profit if the June spot rate turns out to be:
   1. $1.50/pound
   2. $1.60/pound
   3. $1.70/pound
   4. $1.80/pound
   5. $1.90/pound

2. If Boeing wishes to eliminate exchange-rate risk, it will do the following:
   1. Sell 1 million pounds forward today at the 3-month forward quotation of $1.7540 per pound.
   2. In 3 months, it will receive 1 million pounds from British Airways, deliver that sum to the bank against its forward sale, and receive $1,754,000.

   What is the profit made by Boeing with the forward market hedge?

3. What is the disadvantage of entering into a forward contract such as the one above?