Question

Trebble, inc. is a u.s.-based mnc that will need 2 million euros in 90 days to purchase european imports. therefore, trebble purchases a forward contract at a forward rate of $1.05. if the spot rate of the euro in 90 days is $1.00, trebble will pay $________ for the euros and ________ incur an opportunity cost.

Answer 1

Answer: If the spot rate of the euro in 90 days is $1.00, Trebble will pay $2,100,000 for the euros and will incur an opportunity cost.

SinceTrebble Inc. has already purchased a forward contract, it has to buy Euros at the contracted forward rate - $1.05 irrespective of the spot rate.

So, it will buy 2 million Euros at
`2,000,000*1.05 = 2,100,000 USD`

If the spot rate of the euro is $1, then Trebble Inc. will incur a loss of
`USD 100,000 (2,100,000 -2,000,000)`.

If Trebble Inc. chose to buy Euros at the prevailing spot rate on the day it wanted to pay for the imports, it would have saved USD100,000. It could have also invested this amount and earned an interest.

So, the opportunity cost here is the $100,000 it lost on the forward contract plus the interest it could have earned on the amount.

Answer 2

A forward contract is a contract that specifies a trade of a certain commodity at a later date. This is usually done for safety since some products/markets can have very volatile prices. In this case, the contract has been closed so that the price is 1.05$. It does not matter that the Euro dropped later on, the company will still have to pay 2000000*1.05=2100000$. The company will incur an opportunity cost since it did not wait for the price to show up; maybe there could be better planning that made it worth it, but there is still an opportunity cost.