Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to sell next November. In January, they enter into an agreement to buy the wine at a price of 34.62 euro to the case. Payment will be due at the end of November. They expect to sell the wine to restaurants and retailers for $63 per case. Hudson Valley has hedged its foreign exchange risk by entering into a forward contract to purchase euros in November at $1.30/euro. If the spot exchange rate at the end of November is $1.25/euro, the payoff to Hudson Valley for hedging is

Question

Quizplus · Accepted Answer

The payoff from hedging is calculated as the difference between the forward rate and the spot rate, multiplied by the amount in euros. Here, the forward rate is $1.30/euro, and the spot rate is $1.25/euro. The difference is $0.05/euro. For 10,000 cases at 34.62 euros per case, the total amount in euros is 346,200 euros. The payoff is 346,200 euros * $0.05/euro = $17,310. Since the forward rate is higher than the spot rate, the payoff is negative, hence ($17,310).

Hudson Valley Distributors Wants to Be Sure It Has 10,000