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Question - Your treasurer told you how at a previous employer she designed a forward contract on EUR, against USD. She purchased EUR 1m and as of today 60 days remain until expiry. The historic rate was 1.350 while the current rate for same expiry date is 1.500. Assuming the risk-free rates are 3% (simple p.a) in USD and 4% (simple p.a) in EUR, you want to evaluate the treasurer's decision to do so.
a) Compute the fair value of the contract.
b) Explain intuitively without any calculation why the fair value is positive or negative and how it compares to the fair value at the inception of the contract.
c) Provide at least two real-life examples how this forward contract could have been used as a hedging instrument. In each example comment on whether the hedger is better off or worse off, and whether hedging was a correct decision in the first place, and what are the alternative ways to hedge when perfect cashflow matching is not possible.
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