EECS 3101 Lecture Notes - Lecture 29: Spot Contract, Canadian Dollar
28 Jun 2018
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EECS 3101 Lecture 29 Notes
Introduction
Offsetting a Forward Contract
If the forward rate’s premium were constant, then over time the forward rate would
move in tandem with movements in the corresponding spot rate.
For instance, if the spot rate of the euro increased by 4 percent from a month ago until
today then also the forward rate would have to increase by 4 percent over the same
period in order to maintain the same premium
In reality, the forward premium is affected by the interest rate differential between the
two countries and can change over time.
Most of the movement in a currency’s forward rate is due to movements in that
currency’s spot rate.
In some cases, an MNC may desire to offset a forward contract that it previously
created.
EXAMPLE
On March 10, Green Bay, Inc., hired a Canadian construction company to expand its
office and agreed to pay C$200,000 for the work on September 10.
It negotiated a six-month forward contract to obtain C$200,000 at $.70 per unit, which
would be used to pay the Canadian firm in six months.
On April 10, the construction company informed Green Bay that it would not be able to
perform the work as promised.
Therefore, Green Bay offset its existing contract by negotiating a forward contract to sell
C$200,000 for the date of September 10.
However, the spot rate of the Canadian dollar had decreased over the last month, and
the prevailing forward contract price for September 10 is $.66.
Green Bay now has a forward contract to sell C$200,000 on September 10, which offsets
the other contract it has to buy C$200,000 on September 10.
Document Summary
If the forward rate"s premium were constant, then over time the forward rate would move in tandem with movements in the corresponding spot rate. However, the spot rate of the canadian dollar had decreased over the last month, and the prevailing forward contract price for september 10 is $. 66. Green bay now has a forward contract to sell c,000 on september 10, which offsets the other contract it has to buy c,000 on september 10. The forward rate was $. 04 per unit less on its sale than on its purchase, resulting in a cost of ,000 (c,000 $. 04). The forward rate"s premium were constant, then over time the forward rate would move in tandem with movements in the corresponding spot rate. In reality, the forward premium is affected by the interest rate differential between the two countries and can change over time. Most of the movement in a currency"s forward rate is due to movements in that currency"s spot rate.
