EECS 3101 Lecture Notes - Lecture 25: Foreign Exchange Market, Spot Contract, Opportunity Cost
28 Jun 2018
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EECS 3101 Lecture 25 Notes
Introduction
Bank Quotations on Forward Rates
The ability of a forward contract to lock in an exchange rate can create an opportunity
cost in some cases.
EXAMPLE
Assume that, in the previous example, Turz negotiated a 90-day forward rate of $.50 to
purchase S$1,000,000.
If the spot rate in 90 days is $.47, then Turz will have paid $.03 per unit or $30,000
(1,000,000 units $.03) more for the Singapore dollars than if it did not have a forward
contract
Corporations also use the forward market to lock in the rate at which they can sell
foreign currencies.
This strategy is used to hedge against the possibility of those currencies depreciating
over time
EXAMPLE
Scanlon, Inc., which is based in Virginia, exports products to a French firm and will
reeie paet of €400,000 i four oths.
It can lock in the amount of dollars to be received from this transaction by selling euros
forward.
That is, Scanlon can negotiate a forward contract with a bank to sell the €400,000 for
U.S. dollars at a specified forward rate today.
Assume the prevailing four-month forward rate on euros is $1.10.
I four oths, Salo ill ehage its €400,000 for $440,000 (alulated as €400,000
$1.10 ¼ $440,000).
Just as many large banks serve as intermediaries for spot transactions in the foreign
exchange market, they also serve as intermediaries for forward transactions.
Document Summary
The ability of a forward contract to lock in an exchange rate can create an opportunity cost in some cases. That is, scanlon can negotiate a forward contract with a bank to sell the 400,000 for. Just as many large banks serve as intermediaries for spot transactions in the foreign exchange market, they also serve as intermediaries for forward transactions. A forward contract to lock in an exchange rate can create an opportunity cost in some cases. Assume that, in the previous example, turz negotiated a 90-day forward rate of $. 50 to purchase s,000,000. If the spot rate in 90 days is $. 47, then turz will have paid $. 03 per unit or ,000 (1,000,000 units $. 03) more for the singapore dollars than if it did not have a forward contract. Corporations also use the forward market to lock in the rate at which they can sell foreign currencies.
