You are the CFO of a manufacturing company in the United States. Your company expects to receive €10 million Euro from a European customer in six months from now. The current exchange rate between US dollar and Euro is 1.13 USD/EUR. However, you are afraid that the Euro currency may depreciate against the US dollars in the next six months. You may use the Euro currency forward contract to hedge the exchange rate risk. Assume the 6-month Euro currency forward exchange rate is 1.12 USD/EUR.
(1) Should you buy or sell the Euro currency forward contract to hedge the Euro foreign exchange rate risk?
(2) Suppose the company took your suggestion and hedged the Euro currency exchange risk by using the forward contract. The exchange rate between Euro and US dollar turns out to be 1.18USD/EUR at the end of the six months. Calculate how much U.S. dollar your company will receive by converting the €10 million Euro. Also calculate the gain or loss on the forward contract.
(3) What if the exchange rate between Euro and US dollar turns out to be 1.10 USD/EUR at the end of the six months? How much U.S. dollar will your company receive by converting the €10 million Euro? How much is the gain or loss on the forward contract?
(4) Draw the payoff diagram for your company's position in the forward contract.