Assume Sun Microsystems expects to receive €20,000,000 in 90 days. A dealer provide a quote of $0.875 for a currency forward contract to expire in 90 days. Suppose that at the end of 90 days, the rate is $0.90. Assume that settlement is in cash. Calculate the cash flow at expiration if Sun Microsystems enters into forward contract expiring in 90 days to buy dollars at $0.875
Well, let's see how Sun Microsystems is going to cash in on this forward contract. So, they expect to receive €20,000,000 in 90 days, but Sun Microsystems wants to lock in the exchange rate at $0.875 to make sure they get a good deal.
Now, if the rate at the end of 90 days is $0.90, that means the actual exchange rate has gone up. So, Sun Microsystems is actually getting a better deal than they anticipated.
To calculate the cash flow at expiration, we need to determine the difference between the expected exchange rate and the actual exchange rate, and then multiply it by the amount of euros Sun Microsystems is expecting to receive.
The expected exchange rate was $0.875 and the actual exchange rate is $0.90. The difference between these two rates is $0.90 - $0.875 = $0.025.
So, the cash flow at expiration would be €20,000,000 x $0.025 = $500,000.
In summary, Sun Microsystems will receive an additional $500,000 as a result of the forward contract. Not too shabby!
To calculate the cash flow at expiration, we need to consider the amount Sun Microsystems is expecting to receive in euros and the exchange rate at expiration.
Given:
Amount expected in euros = €20,000,000
Forward contract rate = $0.875
Expiration exchange rate = $0.90
To calculate the cash flow at expiration, follow these steps:
Step 1: Convert the expected amount in euros to dollars using the forward contract rate.
Cash flow at expiration = Amount expected in euros * Forward contract rate
Cash flow at expiration = €20,000,000 * $0.875
Cash flow at expiration = $17,500,000
Step 2: Convert the dollars to euros using the expiration exchange rate.
Cash flow at expiration = Cash flow at expiration / Expiration exchange rate
Cash flow at expiration = $17,500,000 / $0.90
Cash flow at expiration = €19,444,444.44 (rounded to two decimal places)
Therefore, the cash flow at expiration, if Sun Microsystems enters into a forward contract expiring in 90 days to buy dollars at $0.875, is €19,444,444.44.