A FRENCH BANK ENTERS INTO A 6-MONTH FORWARD CONTRACT WITH AN IMPOR...

20.

A French bank enters into a 6-month forward contract with an importer to sell GBP 40 million in 6 months at

a rate of EUR 0.80 per GBP. If in 6 months the exchange rate is EUR 0.85 per GBP, what is the payoff for the

bank from the forward contract?

a.

EUR -2,941,176

b.

EUR -2,000,000

c.

EUR 2,000,000

d.

EUR 2,941,176

Correct Answer: b

Rationale:

The value of the contract for the bank at expiration: 40,000,000 GBP * 0.80 EUR/GBP

The cost to close out the contract for the bank at expiration: 40,000,000 GBP * 0.85 EUR/GBP

Therefore, the final payoff in EUR to the bank can be calculated as: 40,000,000*(0.80 – 0.85) = -2,000,000 EUR.

Section:

Financial Markets and Products

Reference:

John Hull, Options, Futures and Other Derivatives, 9th Edition, Chapter 1, “Introduction.”

Learning Objective:

Calculate and compare the payoffs from hedging strategies involving forward contracts and options.

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2015 Financial Risk Manager (FRM®) Practice Exam