EECS 1019 Lecture Notes - Lecture 39: Exchange Rate, Spot Contract, Pound Sterling
21 Jun 2018
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EECS 1019 Lecture 39 Notes
Introduction
Currency Derivatives
For this reason, the cross exchange rate between the euro and British pound has been
fairly stable.
A currency derivative is a contract with a price that is partially derived from the value of
the underlying currency that it represents.
Three types of currency derivatives that are often used by MNCs are forward contracts,
currency futures contracts, and currency options contracts.
Each of these currency derivatives will be explained in turn.
Forward Contracts In some cases, an MNC may prefer to lock in an exchange rate at
which it can obtain a currency in the future.
A forward contract is an agreement between an MNC and a foreign exchange dealer
that specifies the currencies to be exchanged, the exchange rate, and the date at which
the transaction will occur.
The forward rate is the exchange rate, specified in the forward contract, at which the
currencies will be exchanged.
Multinational corporations commonly request forward contracts to hedge future
payments that they expect to make or receive in a foreign currency.
In this way, they do not have to worry about fluctuations in the spot rate until the time
of their future payments.
EXAMPLE
Today, Memphis Co. has ordered from European countries some supplies whose prices
are denominated in euros.
It will receive the supplies in 90 days and will need to make payment at that time.
It expects the euro to increase in value over the next 90 days and therefore desires to
hedge its payables in euros.
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EECS 1019 Full Course Notes
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Document Summary
For this reason, the cross exchange rate between the euro and british pound has been fairly stable. Today, memphis co. has ordered from european countries some supplies whose prices are denominated in euros. It will receive the supplies in 90 days and will need to make payment at that time. It expects the euro to increase in value over the next 90 days and therefore desires to hedge its payables in euros. Memphis buys a 90-day forward contract on euros to lock in the price that it will pay for euros at a future time. Meanwhile, memphis will receive mexican pesos in 180 days because of an order it received from a mexican company today. The cross exchange rate between the euro and british pound has been fairly stable. A currency derivative is a contract with a price that is partially derived from the value of the underlying currency that it represents.
