How to hedge forex

how to hedge forex

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Instructions

Calculate forward rate change and currency exchange difference at maturity. Suppose a FX forward was entered into on December 1, 2009 to exchange 10,000 euros for U.S. dollars on March 1, 2010 at a forward rate of 1 euro = 1.5000 dollars. One month later on December 31, 2009, new forward contracts of the same maturity have a forward rate of 1 euro = 1.4000 dollars. The forward rate difference is 1.5 - 1.4 = 0.1 dollar per euro and the currency exchange difference at maturity is $0.1 per euro x 10,000 euros = $1,000 dollars.

Compute fair value of the forward contract. Discount the currency exchange difference of $1,000 from March 1, 2010 back to December 31, 2009. Assume a

discount rate of 12 percent annually. Since the discount periods are two months from March 1 back to December 31, the rate applied is 1 percent (12 percent/12). The present value or fair value of the forward contract is solved to be $980.30, manually through 1000/(1 + 1 percent)(1 + 1 percent) or using a financial calculator.

Record fair value of the forward contract on balance sheet. The forward's fair value of $980.30 is recorded as an asset on the balance sheet when books are closed on December 31. For forwards that have a decrease in fair value, a liability is recorded. Gain or loss from change in a forward's fair value is recognized in either net income or accumulative other comprehensive income (AOCI) in the equity section.

Source: ehow.com

Category: Forex

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