Queen City Enterprises wants to be sure it has 10,000 cases of Pinot Nior to sell next December.In February, 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 December.They expect to sell the wine to restaurants and retailers for $63 per case.Queen City has hedged its foreign exchange risk by entering into a forward contract to purchase euros in December at $1.30/euro.If the spot exchange rate at the end of December is $1.25/euro, the payoff to Queen City for hedging is

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of 10,000 cases of Pinot Noir in euros:

10,000 cases * 34.62 euro/case = 346,200 euros

Next, we need to calculate the cost of 346,200 euros at the spot exchange rate:

346,200 euros * $1.25/euro = $432,750

Without hedging, Queen City would need to pay $432,750 to purchase the wine. However, they entered into a forward contract to purchase euros in December at $1.30/euro, so they will only pay:

346,200 euros * $1.30/euro = $449,460

Therefore, the payoff to Queen City from hedging is:

$432,750 - $449,460 = ($16,710) or (C) ($17,310).

The negative sign indicates that Queen City paid more due to the forward contract than they would have paid at the spot exchange rate.

Queen City Enterprises Wants to Be Sure It Has 10,000