Suppose IBM has a liability of £1,000,000, payable in three months. The company wants to hedge foreign exchange risk using forward contracts. The current spot rate for the £ is $1.2415/£, and the three-month forward rate is $1.2492/£.

i. What forward position should IBM enter into?

ii. Suppose the spot exchange rate in three months’ time is either $1.2342/£ or $1.2547/£. Using this example, demonstrate how the forward contract in part i helps IBM eliminates foreign exchange risk exposure.

Answer rating: 100% (QA)

i Forward position that IBM enters into 1000000 12492 124... View the full answer