Hansel Corp. frequently uses a forward hedge to hedge its dollar payables. For the next quarter, Hansel has identified its net exposure to the dollar as being $1,000,000. The 90-day forward rate is £0.55. Furthermore, Hanson's financial centre has indicated that the possible values of the US dollar at the end of next quarter are £0.57 and £0.59, with probabilities of 0.50 and 0.50, respectively. Based on this information, what is the expected real cost of hedging payables (a minus represents a saving)?
A) £30,000
B) -£30,000
C) £1,570,000
D) -£1,580,000

Question

Quizplus · Accepted Answer

The expected real cost of hedging payables is the difference between the expected value of the hedged position and the expected value of the unhedged position. The expected value of the hedged position is:£1,000,000 x 0.55 = £550,000The expected value of the unhedged position is:£1,000,000 x 0.57 x 0.50 + £1,000,000 x 0.59 x 0.50 = £580,000Therefore, the expected real cost of hedging payables is:£580,000 - £550,000 = £30,000