A United States company (X) has contracted to provide a service to a European company (Z) (European company uses the Euro Currency[€]). You work for X's CFO as a ?nancial analyst.
Z agrees to pay X €5 Million today as a downpayment and €15 Million in six months (representing the time for X to complete the service agreement with Z). X coverts the 5 Million Euros to $ today. However, X's CFO realizes the currency risk the company faces as the CFO explains to you that we will need to covert those 15 Million Euros to $ when we receive them in six months. The CFO says we know the current exchange rate ($1.30 per €1). However, we have no idea what the $/€ will be in six months. The current exchange rate today is $1.30 per €1 (meaning one euro can be bought or sold for $1.30 US Dollars).
X's CFO gives you the following possible scenarios for rates six months in the future:
1. $1.40 per €1
2. $1.20 per €1
3. Rates to not change - stay constant at $1.30 per €1 CFO tells you that the large bank that X deals with has agreed to enter into a forward contract with X. The bank has agreed to buy the €15 Million in six months when we receive them at a $1.29 per €1.
Question 1. The CFO asks you to compute the amount of $X receives on the €5 Million it receives today at the current $1.30/€1 exchange rate.
Question 2. The CFO asks you to compute the amount of $ X receives in six months for the € 15 Million if X does does nothing, and the exchange rates move to the three rates above. Here, Z pays X €15 Million in six months and X has not contracted with the large bank. Thus, X converts the $ to € and receives three possible $ amounts. Thus, you are to compute the three possible outcomes.
Question 3. The CFO asks you to compute the amount of $ X receives in six months if we go ahead with the bank contract for the €15 Million today. Here, X enters into an agreement to sell the 15 Million Euros it receives from Z to the Bank at a $1.29 per one euro [€].
Question 4. Looking at this from the bank's perspective. Say the bank does the above deal for the 15 Million Euros - agrees to buy them from X for $1.29 per €1. Say, the bank deal does not go quite as well as the bank planned. Say, the Euro moves to $1.15 per €1.
Further, the bank does not want euros either. The bank buys the Euro from X at $1.29 and then decides to sell them. The bank gets $1.15 per €1. How much does the bank the make or lose here in $?
Question 5. Say, we are down the road six months. X did the deal with the Bank and all played out as planned. Currency rates for this question only moved to the $1.40 per €1. The CFO just received a call from one of X's company board members. The board member questions why she did the currency deal. He (the board member) says: will, if you had not have used the contract with the bank we could have sold those Euros for $1.40 each today, and I see we (X) only received the $1.29 contract price from the Bank.
The CFO asks you to draft a few sentence response to the board member on justi?cation for using the contracts. [Hint: here you have a situation where somebody has second guessed your decision based on what is known now (rates moved to $1.40) against what was not known when the contract was entered into where the rate would actually end up in six months].