Exchange rate risk is the risk that tomorrow

Exchange rate risk is the risk that tomorrow - E xchange...

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Exchange rate risk is the risk that tomorrow’s exchange rate will differ from today’s rate. As indicated earlier, it is extremely unlikely that the future spot rate will be exactly the same as the forward rate quoted today. Assume that you are going to receive a payment denominated in pounds from a British customer in 30 days. If you wait for 30 days and exchange the pounds at the spot rate, you will receive a dollar amount reflecting the exchange rate 30 days hence (that is, the future spot rate). As of today, you have no way of knowing the exact dollar value of your future pound receipts. Consequently, you cannot make precise plans about the use of these dollars. If, conversely, you buy a future contract, then you know the exact dollar value of your future receipts, and you can make precise plans concerning their use. The forward contract, therefore, can reduce your uncertainty about the future, and the major advantage of the forward market is that of risk reduction. Forward contracts are usually quoted for periods of 30, 90, and 180 days. A contract for any
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This note was uploaded on 04/11/2011 for the course FIN 370 taught by Professor Unknown during the Spring '08 term at University of Phoenix.

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