Suppose that Pixar, the U.S. animation company, receives an order today for the delivery of 1 million DVDs of the movie "Frozen" to a wholesaler in Germany in exactly three months. The order contract stipulates that the wholesaler must make a payment of 10 million Euros to the company at the time of delivery. The company must then convert this entire payment into U.S. dollars to pay its employees and production costs. The company anticipates the Euro to depreciate relative to the dollar and considers hedging the foreign exchange risk through the use of a forward contract to sell Euros for dollars. Today's spot and 3-month forward exchange rates are given below:
Spot Price: 1 Euro = 1.382 US$
Forward Price: 1 Euro = 1.311 US$
a) Assuming that there are no transactions costs, how many dollars will Pixar receive in three months if it enters into the forward contract?
b) If Pixar does not hedge its risk and the exchange rate remains constant, how many dollars will it receive in three months?
c) Now, suppose that the Euro does in fact depreciate and that its spot price three months from today equals $1.298. If Pixar does not hedge, how much revenue does the company lose from the exchange rate fluctuation (compared to what they would have made without hedging if the exchange rate had remained constant)?
d) Assuming the spot rate equals $1.298 three months from today, would entering into the forward contract have been a good idea in this case? Explain your answer.
e) If after three months the Euro has appreciated by 5% and Pixar has a hedged position, what is the value of its forgone revenue (i.e. what are the company's lost profits)?