IBF Group 6_Inclass Assignment#3

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Course : International Banking and Finance INTL 702(007) Assignment Title : In-Class Assignment #3 Group 6 : Ashwini Sharma Preksha Patel Saumya Shah Sakshi Patel Sarveshwar Modi Professor : Francis Olatoye Due Date : March 17, 2024

Question 1. If you enter into a forward contract to sell a currency, in this case the euro, in the future, the forward rate will be agreed when the contract is made. This interest is based on the current interest at the time of the Agreement, adjusted by the difference in interest between the two relevant currencies. For example, if the spot rate on June 28, 2022, were $1.10 for each euro, the forward would be locked in at that rate for a sale of 10,000 euros. To determine if you are better or worse. This contract depends on the spot rate and the locked forward rate. If the euro is weak against the USD - meaning the current exchange rate is below $1.10/euro - you are better off because you are selling euros at a higher rate than the market rate. Conversely, if the euro strengthened - meaning the current spot rate is higher than $1.10/euro - you would be worse off because you could sell your euros at a higher price on the open market. The value of a forward contract is in the hedge it provides against currency fluctuations, protecting you when the currency moves against you, but can also limit your profits when the currency moves in your favor. Question 2: Let's compare these two rates: ● Forward Contract Rate: 1 Euro = 1.18 USD (FRED, 2024) ● Spot Exchange Rate: 1 Euro = 1.01 USD (FRED, 2024) Since the forward contract rate (1 Euro = 1.18 USD) is higher than the spot exchange rate (1 Euro = 1.01 USD) on the maturity date, the exporter is in a favorable position. Here's why: ● Benefit to the Exporter: The exporter is obligated to sell their 10,000 Euros at the higher rate of 1.18 USD per Euro, as per the terms of the forward contract. This means that despite the

decrease in the spot exchange rate over the contract period, the exporter can still sell their Euros at a higher rate than the current market rate. ● Locking in Profit: By entering into the forward contract when the exchange rate was favorable (1 Euro = 1.18 USD), the exporter effectively locked in a higher selling price for their Euros. This protects them from potential losses resulting from adverse movements in the exchange rate. Given the comparison between the forward contract rate and the spot exchange rate on the maturity date, the exporter is better off having entered into the forward contract. They can sell their Euros at a higher rate than the current market rate, ensuring a favorable outcome for the exporter. Question 3: According to (“Pros and Cons of a Forward Contract,” 2020), The forward contract is clearly advantageous if you enjoy certainty. The trade war with China has an impact, the Federal Reserve's activities and policies, and even unstable internal politics can all exert pressure on the dollar and other currencies and provide swings. When it comes to bigger amounts, even a small fluctuation of a percentage point in the exchange rate can have a significant impact. A forward contract helps you control expenses within a set budget when you place large orders from foreign suppliers or have long-term agreements elsewhere. Currency fluctuates both ways; a forward contract hedges against potential losses and protects your company from gains in the event that the value of the dollar declines. You can be forced to pay less than the going rate if the value of the dollar increases. A forward contract provides confidence if you are risk-averse or operate within tight budgetary constraints. A lot relies on your attitude toward risk and what the firm can tolerate. Other currency tools that track and target rates might be a useful approach to manage your foreign payments if you can tolerate a little risk and your company can weather any currency declines or wait for the rates to improve.

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Question 4: There are several reasons why the Euro is trading at or close to parity with the USD. First of all, it shows how the US and the Eurozone's monetary policies and economic data compare. The European Central Bank's more aggressive approach and improved economic data may help the euro relative to the US dollar. Differential interest rates also have a significant impact; higher rates in the Eurozone draw in international investors and increase demand for the Euro. Currency valuations are also influenced by trade relations and tariffs between the US and the Eurozone, as well as political stability in the Eurozone relative to the US. Furthermore, the COVID-19 pandemic's lasting effects and changes in key economies like China have an impact on attempts to revive the economy.The Euro-USD exchange rate fluctuates due to economic recovery attempts. Finally, mood and market speculation matter because short-term changes in currency markets can result from speculative activity and investor expectations. Overall, the Euro's parity with the US dollar highlights how complex market dynamics, policy choices, and economic fundamentals interact to shape currency valuations in the global economy (The Associated Press, 2022). Question 5: Volkswagen When analyzing a company and assessing whether they have taken action to hedge against this foreign exchange risk, we chose to look at Volkswagen. The Volkswagen Group uses a variety of tactics to reduce foreign exchange risk, which is a major issue for global businesses. Using forward contracts is one such tactic that helps Volkswagen protect itself against unfavorable currency changes by guaranteeing exchange rates for future transactions denominated in foreign currencies. Volkswagen may also make use of currency options, which provide them with the freedom to purchase or sell money at predefined rates and protect them against adverse fluctuations in exchange rates. In order to effectively lower overall exposure to currency risk, the corporation

may also use natural hedging measures, such as aligning revenues and expenses in the same currency or diversifying production and sales over multiple areas. Additionally, in order to minimize the requirement for currency conversion and lower its exposure to exchange rate fluctuations, Volkswagen may use netting to offset payables and receivables in the same currency. The company is able to effectively manage its currency risk while focusing on its main business operations thanks to the use of financial derivatives like currency swaps and futures contracts. These tactics, which are customized to the demands of the business and the state of the market, assist Volkswagen in navigating the challenges of managing foreign exchange risk and protect its bottom line. To gain a comprehensive understanding of Volkswagen's hedging strategies and their efficacy, consulting the company's financial reports or public comments would be beneficial ( Financial Risks - Volkswagen Group Annual Report 2022 , n.d.).

References: 1. FRED. (March 2024). U.S. Dollars to Euro Spot Exchange Rate . https://fred.stlouisfed.org/series/DEXUSEU 2. Moneycorp USA. (2020, June 26). Pros and Cons of a Forward contract . https://www.moneycorp.com/en-us/news-hub/pros-and-cons-of-a-forward-contract/ 3. The Associated Press. (2022, July 13). Explainer: What’s the impact of euro parity with the dollar? KPBS Public Media. https://www.kpbs.org/news/national/2022/07/13/explainer-whats-the-impact-of-euro- parity-with-the-dollar 4. Volkswagen Group. (n.d.). Financial risks - Volkswagen Group Annual Report 2022 . https://annualreport2022.volkswagenag.com/group-management-report/report-on-risks- and-opportunities/risks-and-opportunities/financial-risks.html#:~:text=Foreign %20currency%20risk%20is%20reduced,large%20percentage%20of%20components %20locally.%5C

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