@Ju1882 5 August 2020 more from that month

Forward Exchange contract - Foreign Exchange Risk management technique.

****Forward Exchange Contract**** Forward Exchange Contract is a contract between two parties, where one agrees to deliver a certain amount of foreign exchange at an agreed rate at a fixed future date to the other party. Forward Exchange Contracts are used to hedge against the adverse movement in exchange rate. ****Example**** On 01/Aug/2028, a European firm exported a machinery to a USA Firm for 1,00,000 $ on a 3 months credit basis. On 01/Aug/2020, exchange rate was 1$=0.8000 Euro. At the end of credit period ( 31/Oct/2020 ) Spot exchange rate is (I) 1$=0.7800Euro, in this case European firm will loose 0.0200 Euro/$, therefore Loss on foreign exchange will be 2,000 Euro (0.0200X1,00,000). (ii) 1$=0.8100Euro, in this case firm will gain 0.01 Euro/$, therefore Gain on foreign exchange will be 1,000 Euro (0.0100X1,00,000). ****Use of Forward Contract**** To limit exchange loss, European firm can use Forward Contract. Suppose the firm enters into a Forward Contract to sell 1,00,000$ @ 1$=0.7950Euro, then at the end of 3 months credit period (31/Oct/2020), whatever be the exchange rate (higher or lower ) firm will receive @ 1$=0.7950Euro, therefore firm can limit it's loss to 0.0050 Euro/$. and Loss on foreign exchange will be limited to 500Euro. ****Conclusion**** Forward contract limits the expected Foreign Exchange loss, but doesn't give benefits of foreign exchange gains. Thank you for reading.