IBM enters into a forward contract to purchase 200 000 euros at a rate of $1.90/euro one year from today. If the spot exchange rate is $2/euro one year later, what is the dollar amount that IBM must pay to receive the euros?

Question

Quizplus · Accepted Answer

According to the forward contract, IBM is obligated to purchase 200 000 euros in one year at a rate of $1.90/euro. Therefore, the total cost in dollars would be:
200 000 euros x $1.90/euro = $380 000
However, the spot exchange rate one year later is $2/euro. Therefore, if IBM were to purchase the euros on the spot market, it would only cost:
200 000 euros x $2/euro = $400 000
Since the forward rate is lower than the spot rate, IBM would save money by fulfilling the contract and paying the $380 000 agreed upon in the contract. Thus, the answer is A.

IBM Enters into a Forward Contract to Purchase 200 000