Question

On July 1, 2013, a Japanese company enters into a forward contract to buy $1 million with yen on January 1, 2014. On September 1, 2013, it enters into a forward contract to sell $1 million on January 1, 2014. Describe the profit or loss the company will make in dollars as a function of the forward exchange rates on July 1, 2013 and September 1, 2013.

Answer 1

Profit (loss) from the contract = (FER2 - FER1) million yen

Step-by-step explanation:

Let FER1 represents the forward exchange rates for the contracts entered into by the company on July 1, 2013, and let FER2 represents the forward exchange rates for the contracts entered into by the company on September 1, 2013.

Also, let SPOT represents the spot rate on January 1, 2014.

Since all exchange rates are measured as yen per dollar, we therefore have:

First contract profit = (SPOT - FER1) million yen

Second contract profit = (FER2 - SPOT) million yen

Profit (loss) from the contract = First contract profit + Second contract profit

Removing the million yen first and later add to the final answer, we have:

Profit (loss) from the contract = (SPOT - FER1) + (FER2 - SPOT)

Profit (loss) from the contract = SPOT - FER1 + FER2 - SPOT

Profit (loss) from the contract = (FER2 - FER1) million yen

Therefore, the profit or loss the company will make in dollars as a function of the forward exchange rates on July 1, 2013 and September 1, 2013 is Profit (loss) from the contract = (FER2 - FER1) million yen.