Forward Contract for Liability
Forward Contract or agreement can also be set for
to hedge the risk associated with expected payment of Liability; hedging
process can be explained with help of an example;
Example
UK
Based Company have made some purchases from usa and expected to pay an amount
of $ 160,000, payment would be made in
four month time from now, and four month forward rate by banks are USD/Pound is
1.70000-1.8000; how risk can be hedged using forward agreements?
Solution
1. Set
Agreement
An agreement would be entered into using the
forward rate to hedge the risk associated with the payment of liability i.e.
calculating the exact amount of liability is to be paid in four month time.
2. Rate for
Hedging
It is important note that it is an liability,
therefore the rate will be apply to pay more, as you are always at disadvantage
at rate selection.
3. Calculate
Liability
Agreement was set at rate of
1.7000, now this rate can be used to calculate the expected income in pounds.
160,000/1.7
= 94,118
(Pound)
