Question

Thornton, Inc. needs to invest five million Nepalese rupees in its Nepalese subsidiary to support local operations. Thornton would like its subsidiary to repay the rupees in one year. Thornton would like to engage in a swap transaction. Thus, Thornton would:a. convert the rupees to dollars in the spot market today and convert rupees to dollars in one year at today's forward rate.b. convert the dollars to rupees in the spot market today and convert dollars to rupees in one year at the prevailing spot rate.c. convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at today's forward rate.d. convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at the prevailing spot rate.

Answer 1

c. convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at today's forward rate.

Step-by-step explanation:

In the given case, Thornton requires to buy foreign currency i.e Nepalese rupees. So today, it needs to sell it's own currency i.e USD at current spot rate and purchase 5 million Nepalese rupees in return.

Now, since it will be in receipt of Nepalese rupees after one year and since US Dollar being a stronger currency, it is exposed to risk in case of US Dollar further strengthens over the period, the proceeds upon conversion would be lesser, resulting into a loss.

To hedge it's position against such a risk of currency fluctuation, Thornton would enter into a one year forward contract wherein it'll sell Nepalese rupees received after one year at a predetermined forward rate today and thereby limit it's loss.