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Here is a forward contract hedge example that demonstrates how a currency forward can be used.
In this example we will look at a UK based business who’s European subsidiary will be receiving EUR 750,000 for a new contract and how a FX forward can be used to hedge the exposure.
The EUR 750,000 will be main in monthly installments over the next 12 months and is guaranteed revenue.
In this forward contract hedge example we will assume that the company has budgeted in their profit forecasts based on the current exchange rate so they need to hedge the EUR 750,000 exposure in case the GBPEUR rate moves against them.
- This can be done by a series of currency forwards to settle in monthly intervals.
- This means that each month the company will be able to convert EUR 62,500 into GBP at the exchange rate on the day the contract was signed.
- Enabling them to accurately budget their profit forecasts.
- If the exchange rate moves against them they do not have to worry about a decrease in profits.
- However, as it is a hedge they will not benefit if the exchange rates moves in their favour over the course of the year.
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