RL Company is a Hong Kong-based company and purchases the raw materials from Germany. RL will settle the payment of the materials in six months. This payment will be in Euro, RL plans to hedge against a rise in the value of the Euro over the next six months. The spot rate of the Euro is HK$ 8.55. The HK interest rate is 1.5%, and the Euro interest rate is 4.5%. Presume that interest rates remain fixed over the coming six months. Assume that 360 days for a year.
(a) How can RL Company use a forward contract to hedge any possible exchange rate risk?
(b) Estimate the no-arbitrage price at which RL Company could enter into a forward which expire in six months.
(c) After 60 days when RL Company entered into the forward contract. The spot rate is HK$8.10. Assume the interest rates remain fixed, update the value of RL Company’s forward position. Also, decide whether RL Company short or long the forward contract.