A U.S. firm will need 100,000 in 90 days to pay for British imports. The firm tries to hedge this transaction using a forward contract. We know the following information:

*Spot exchange rate: 1=$1.38.

*90-day forward exchange rate: 1 = $1.40 .

(a) Should this firm buy or sell a forward contract if it wants to eliminate the uncertainty of the dollar payment for this accounts payable (A/P)?

(b) If management's forecast of the spot rate 90 days later is:

Possible spot rate of in 90 days Probability

$1.30 25%

$1.36 25%

$1.40 30%

$1.45 20%

calculate the expected (or average) dollars paid in 90 days for the forward hedge you have chosen in part (a). Calculate the expected (or average) real costs of this hedging strategy relative to the no hedging scenario.

(c) Draw a net profit graph for this forward contract.