Posted by forex at 12:23 AM
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Foreign Exchange Forward
1.
Price the car to yield a profit.
Imagine you are an American importer of Japanese cars and you have contracted for a delivery of cars in three months, with payment of 5,000,000 yen on delivery of the cars. You want to know exactly how many dollars you need to pay for the yen so that you can price the cars at a level that yields you a profit. You are worried that the yen will increase in value against the dollar and the cars will cost you more money.
2. Call your bank and ask your banker to quote you the $/yen three-month outright forward rate.Your banker quotes $/yen 90.25 to 90.50 per dollar for the three-month outright rate. The bank is saying that it buys dollars and sells yen using the left side of the quote, 90.25, and sells dollars and buys yen using the right hand side of the quote, 90.50.
3. Take a calculator and divide 5,000,000 yen by 90.25, which is the bank's dollar-buying rate. You want to sell dollars and buy 5,000,000 yen to pay for the cars.The amount is $55,401.66.
4. Instruct your banker to go ahead and contract to sell you 5,000,000 yen for delivery in three months at the $/yen three-month forward rate of 90.25. You now know that in three months you will deliver to your bank $55,401.66 in exchange for the 5,000,000 yen. The exchange rates are locked in, and even if the yen strengthens in the interim three months you have hedged against that event and will not pay a cent more for the cars.
Foreign Currency Swap
5.
Swaps are a neat and tidy hedge.
Fast forward three months as the same American importer of cars. The forward contract has matured and you have 5 million yen in your bank account, but the delivery of cars has been delayed a month. You don't want to sit on your yen because you will have a currency exposure.
6. Call your bank and request a quote from your banker for a one-month $/yen swap. A swap is a simultaneous purchase or sale of a currency at spot (spot is delivery of currencies in two business days) and an opposite purchase or sale of a currency at some agreed date in the future.
7. Agree to sell to your bank 5 million yen and buy dollars at spot, and simultaneously agree to buy back the 5 million yen in one month's time when you need to pay for the imported cars. You can then invest the dollars in a money market account and earn interest for a month. You have effectively hedged against any big change in the $/yen exchange rate.