Hedging the Market

Suppose that you are bidding on a tender to provide a foreign government with earth-moving equipment. The bid is due next week, the government will announce the winning bid four months later, and the equipment is to be delivered exactly one year from now. You offer to supply the equipment at 412,500,000 euros, a price which you think stands a reasonably good chance of winning. However there is no certainty of winning the bid. You have set your dollar price based on your estimated cost plus transportation and the one-year-forward exchange rate currently being quoted of 0.86 euros per US dollar. Describe how you would hedge your possible exchange rate exposure for your bid.

We will utilize the forward market hedge to prevent exchange rate fluctuation losses. Here assuming that the company is based out of US and supplying the equipment to a foreign firm who in return will provide the money in Euros.

Now considering that, the firm wins the tender and will receive 412.5 million Euros after an year and it could hedge its exchange rate risk by forward hedging.

What would the firm do?

It would sell the Euros Forward. This would guarantee the firm a precise amount of dollar to which the Euros can be converted into Dollars an year from now.

Forward Exchange Rate after a year: = 0.86 Euros per US Dollar

                                            = 1.1627 Dollar per Euro

This Guarantee the US firm, 479.61 Million Dollars irrespective or exchange rate fluctuation.

The only risk associated is the prevailing spot rate an year from now. If the spot rate from an year is more than 1.1627 then the firm can make the respective difference of exchange rate less in total. But forward hedge eliminate the risk of settling for an amount less than 479.61 Million Dollar an year from now..