The following information is to be used in answering questions 36?38.
U.S. borrowing rate for 1 year = 9.5%
U.S. deposit rate for 1 year = 8.7%
French borrowing rate for 1 year = 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote = $0.1763?78
French franc 1?year forward quote = $0.1729?47
-1996, DEC hedges a FF million receivable due in 180 days. The current spot rate is FF 1 = $0.18834 and the 180?day forward rate is FF 1 = $0.1862If the spot rate at the end of 180 days is $0.18728, how much has the forward market hedge cost DEC?
A) $6,688
B) $3,392
C) $3,296
D) DEC gains $6,688 on the hedge

Question

Quizplus · Accepted Answer

To calculate the cost of the forward market hedge, we need to compare how much DEC would receive at the end of 180 days using the spot rate and the forward rate.

Using the spot rate:
FF 1 million = $0.18834 million/FF x FF 1 million = 5,307,597 FF
At the end of 180 days, FF 1 = $0.18728, so FF 1 million = $0.18728 million/FF x FF 1 million = $5,276,212
DEC would receive $5,276,212 using the spot rate, resulting in a loss of $31,385.

Using the forward rate:
FF 1 million = $0.1862 million/FF x FF 1 million = $5,378,068
DEC would receive $5,378,068 using the forward rate, resulting in a cost of $81,768 ($5,378,068 - $5,296,300).

Therefore, the forward market hedge cost DEC $3,296 (cost of using the forward rate - amount received using the spot rate). The correct answer is C.

The Following Information Is to Be Used in Answering Questions