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Here, we have to roll the hedge forward with portfolio USD exposure increasing and show its calculations –
Square off USD 2,500,000 forward today @ spot price of 0.8875 resulting in cash inflow of 2218750 (SELL USD/EUR)
Now, buy USD/EUR forward of amount 2,650,000 @ 0.8901 resulting in outflow of 2358765
So, net cash outflow = 2358765-2218750 = 140015
Ps. What’s surprising is they haven’t shown the initial calculation of buying the USD/EUR foward one month back into the calculations to calculation net cash flow.
How does the new forward create any cash flow now?
old forward short USD/long EUR= you deliver $2,500,000 and receive 2,500,00/0.8944 = €2,795,170 (Should we not divide the rate instead of multiply?)
spot to offset initial forward = you receive $2,500,0000 and pay 2,500,000 / 0.8875 = -€2,816,901 (Should we not divide the rate instead of multiply?)
the $ flows cancel out
in € you have €2,795,170 – €2,816,901 = -€21,731
Please clarify.
So, I think you just used USD/EUR rate as its given. But, practically that exchange has been quoted wrong as in the notation is wrong.
Please check current USD/EUR rate. Real mein 1 USD = 0.86 EUR (current rate).
They should have not given the quote with EUR as base rate. They have given EUR as base rate just for us to judge what to buy or sell forward and use the relevant bid offer rate
Thankyou Sir, but I am still not able to understand the below doubts:
1. How does the new forward create any cash flow?
2. Ignoring the prevailing real USD/EUR rates, is the given solution correct in calculating the Cash Flows by multiplying the rates instead of dividing?
If you consider 1 USD = 0.85 EUR (just an example) then you will use multiplication why division.
Think about it. Have usd exposure.