On March 1, 2013, Chacin Ltd. issued a purchase order to No Worries (New Zealand)Inc. to acquire equipment for $400,000 New Zealand dollars. On the same day, Chacin entered into a forward contract to receive $400,000 New Zealand dollars on July 31, 2013. The equipment was delivered on June 1, 2013 and payment was made July 31, 2013. Chacin has an April 30 year-end. The following information has been provided: $$\begin{array} { | l | c | c | }
\hline \text { Date } & \text { Spot Rate } & \frac { \text { Forward rate to July 31 } } { 2013 } \
\hline \text { March } 1,2013 & .7686 & .7810 \
\hline \text { Apri1 30,2013 } & .7702 & .7818 \
\hline \text { June 1,2013 } & .7940 & .7985 \
\hline \text { July 31,2013 } & .7995 & \text { n/a } \
\hline
\end{array}$$ Assume that the transaction qualifies as a hedge. What is the cost of the hedge?

Question

On March 1, 2013, Chacin Ltd. issued a purchase order to No Worries (New Zealand)Inc. to acquire equipment for $400,000 New Zealand dollars. On the same day, Chacin entered into a forward contract to receive $400,000 New Zealand dollars on July 31, 2013. The equipment was delivered on June 1, 2013 and payment was made July 31, 2013. Chacin has an April 30 year-end. The following information has been provided: $$\begin{array} { | l | c | c | } 
\hline \text { Date } & \text { Spot Rate } & \frac { \text { Forward rate to July 31 } } { 2013 } \
\hline \text { March } 1,2013 & .7686 & .7810 \
\hline \text { Apri1 30,2013 } & .7702 & .7818 \
\hline \text { June 1,2013 } & .7940 & .7985 \
\hline \text { July 31,2013 } & .7995 & \text { n/a } \
\hline
\end{array}$$ Assume that the transaction qualifies as a hedge. What is the cost of the hedge?

Quizplus · Accepted Answer

The cost of the hedge is the difference between the forward rate and the spot rate on the date the forward contract was entered into. In this case, the forward rate was .7810 and the spot rate was .7686, so the cost of the hedge is .7810 - .7686 = .0124. The cost of the hedge is then multiplied by the amount of the forward contract, which is $400,000, to get the total cost of the hedge, which is .0124 * $400,000 = $4,960.

On March 1, 2013, Chacin Ltd Assume That the Transaction Qualifies as a Hedge