1. In July 2008, Aracruz Celulose, a Brazilian company, tried to hedge its FX risk on $500 mil. USD in sales over three months. The spot USD/BRL was 1.60 (i.e., 1 USD = 1.60 BRL). The interest rate on BRL was 12.25% per year, while the interest rate on USD was 2% per year. For simplicity, use continuous compounding to compute interest.
   1. Explain how Aracruz could hedge its FX risk using USD/BRL forwards. When describing the company's hedging strategy, also calculate the theoretical three-month forward exchange rate for USD/BRL.
   2. Suppose Aracruz took the FX forward position at the theoretical forward exchange rate. In September 2008, Lehman Brothers collapsed, causing USD/BRL rate to rise dramatically to 2.27 by October 2008. How much did Aracruz lose on its forward contract? Answer the loss amount in BRL.

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Hedging with USDBRL Forwards for Aracruz Celulose Heres how Aracruz could hedge its FX risk and the impact of the Lehman Brothers collapse Hedging Strategy Sell BRL forward Aracruz needs BRL in three ... View the full answer