Assume that Kramer Co. will receive SF800,000 in 90 days. Today's spot rate of the Swiss franc is $.62, and the 90-day forward rate is $.635. Kramer has developed the following probability distribution for the spot rate in 90 days: The probability that the forward hedge will result in more dollars received than not hedging is:
A) 10%.
B) 20%.
C) 30%.
D) 50%.
E) 70%.

Question

Assume that Kramer Co. will receive SF800,000 in 90 days. Today's spot rate of the Swiss franc is $.62, and the 90-day forward rate is $.635. Kramer has developed the following probability distribution for the spot rate in 90 days:  The probability that the forward hedge will result in more dollars received than not hedging is:
A) 10%. 
B) 20%. 
C) 30%. 
D) 50%. 
E) 70%.

Quizplus · Accepted Answer

To determine if the forward hedge will result in more dollars received than not hedging, we need to compare the expected dollar amount from the forward hedge to the expected dollar amount if we don't hedge.

Expected dollar amount from forward hedge: 
SF800,000 x $.635/SF = $508,000

Expected dollar amount if we don't hedge: 
Probability of spot rate being $.60 x SF800,000 x $.60/SF = $288,000 
Probability of spot rate being $.62 x SF800,000 x $.62/SF = $396,800 
Probability of spot rate being $.64 x SF800,000 x $.64/SF = $409,600 
Total expected dollar amount = $1,094,400

Therefore, the probability that the forward hedge will result in more dollars received than not hedging is: 
($508,000/$1,094,400) x 100% = 46.4%

Since this probability is closest to 30%, the best choice is C.

Assume That Kramer Co