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I have done the ACCA mock exam for the march 2018 session. In that question paper question No.14 felt like tricky. Please help me out.
Question. A UK company expects to pay $700000 in 8 month’s time.
Current Exchange rate 1.7550$/£
4 month exchange rate 1.7819$/£
12 month exchange rate 1.8045$/£
Calculate receipts in £ if forward hedge is taken?You need to estimate the 8 month forward rate and you do it by approximating between the 4 month and 12 month forward rates.
There are 8 months between 4 months and 12 months, so we assume that the change each month is (1.8045 – 1.7819) / 8
To get that 8 month forward rate, we take the 4 month forward rate and then add on the extra 4 months and the change per month just calculated.
So the 8 month forward rate = 1.7819 + 4 x ((1.8045 – 1.7819)/8) = 1.7932
(Alternatively, and quicker for this particular question, since 8 months is half way between 4 months and 12 months, we can take half way between the 2 forward rates. (1.7819 + 1.8045) / 2 = 1.7932. However, had it been (for example) a 7 month forward rate that we needed, then you would need to do it the first way.)
Having got the forward rate, you then use it in the normal way as I explain in my free lectures.
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