The current spot exchange rate is $1.45/€ and the three-month forward rate is $1.55/€.Based upon your economic forecast,you are pretty confident that the spot exchange rate will be $1.50/€ in three months.Assume that you would like to buy or sell €100,000.What actions would you take to speculate in the forward market? How much will you make if your prediction is correct?

Question

Quizplus · Accepted Answer

To speculate in the forward market, you would take a short position in a forward contract on euro because you are confident that the euro will weaken and the forward rate will be higher than the spot rate in three months. By taking a short position, you are selling euros at the higher forward rate and buying them back at the lower spot rate in three months, resulting in a profit of the difference between the two rates. The profit would be $5,000 if your prediction is correct, calculated as follows: 
Profit = (€100,000 x ($1.55/€ - $1.50/€)) = $5,000

The Current Spot Exchange Rate Is $1